Editor’s note: Over his 25-plus years on Wall Street, our friend and colleague Enrique Abeyta has seen investors make mistakes time and time again. But you don’t have to be one of them. Today, Enrique shares four simple concepts to take your investing to the next level, and discusses one of the highest-upside corners of the market right now…
I spend a lot of time thinking about the effect of psychology – and even human biology – on trading and investing.
The data are absolutely overwhelming: The vast majority of investors and traders underperform the market.
This is because they don’t have a good understanding of those psychological effects or how to manage them.
It’s all too easy to let your emotions influence your investing… which leads to poor results.
The first step is to become familiar with the inherent biases we as humans bring to the table.
The next step is coming up with a plan to manage them in order to become a successful investor. So today, I’ll highlight four simple rules that all investors should keep in mind…
1. Buy Low, Sell High
This is something that every investor talks about… but many people likely forget about it in day-to-day trading.
Many investors understand the “buy low” portion of this equation, but almost never do even an adequate job with the “sell high” portion.
I’ve said it many times: you don’t want to get caught in the “middle” of trading and investing. If you’re trading, trade a lot. If you’re investing, don’t trade at all.
And the single most powerful tool in trading is to sell high.
I even have a Post-it note that says these words – “Buy Low, Sell High” – on my computer screen. This should be the single piece of “math” that every investor thinks about each day.
2. Be Selective
There are approximately 5,000 publicly traded stocks on U.S. exchanges. Roughly two-thirds of those are what would be considered “liquid” – or trading at least $2 million to $3 million of value per day.
For a diversified investing portfolio, you likely only need 10 to 15 stocks.
But for a trading portfolio, remember that you can spend much of your time without any positions. In this case, most folks also likely don’t need more than 10 to 15 positions at any given point. It’s important to stay agile and flexible.
It sounds smart to have opinions on lots of subjects and many stocks… but it usually isn’t a good way to make money.
The best way to is to be patient and highly selective with your investments – wait for the absolute best ideas.
The allure of having an opinion or getting involved in the excitement of a new story often overwhelms selectivity. Keep your number of positions small by choosing only the best ideas.
One simple exercise is what I call “force curving.” Before you add a new investment, decide what it will replace in your current portfolio. If you can’t find one, then you shouldn’t make the new investment.
3. To Go Up by a Lot, It First Needs to Go Up by a Lot
When it comes to investing, you should only focus on really big returns.
The reality is that every single year (even during recessions) 50-plus stocks go up by 100% or more. If you look at any three-year rolling period, there are hundreds.
So if you only own 10 to 15 stocks, why shouldn’t you focus on those that can go up a lot?
However, a frequent perception often prevents investors from properly identifying these kinds of opportunities: The phrase, “Oh, it’s already up by a lot.”
This is one of the most common investing phrases out there, and it’s also one of the most damaging.
To understand why, consider this simple mathematical concept: For a stock to go up by 500%, it has to go up by 100% first.
So the next time you’re thinking about trying to find big-upside investment ideas, think about starting with stocks that have already doubled or tripled.
4. Look for Big Market Potential
The single strongest correlation I see with stock prices is with the earnings of the underlying companies.
If a company makes $1 of earnings per share (“EPS”) today and will earn $5 of EPS in the future, its stock will almost always go up… and usually by a lot.
The move higher might be quick… it might be slow… but the stock still goes up.
(The inverse also holds true – if a company is earning $5 of EPS today and it earns $1 of EPS in the future, its stock will almost always go down.)
So if you want to find high-return stocks, the most important thing to look for is a company with the potential for this kind of earnings growth.
One example is with special purpose acquisition companies (“SPACs”).
When I started on Wall Street in the mid-1990s, there was a robust initial public offering (“IPO”) market in which many small, growth-oriented investment banks brought high-growth companies public.
These were the kinds of companies where EPS could go from $1 to $5… and their stocks produced massive returns for investors.
But over the past 25 years, those banks were gobbled up by larger banks. Those larger banks – like Goldman Sachs (GS) – are only interested in the biggest IPOs.
This has meant that for the past decade, we’ve seen a great roster of emerging-growth companies with huge potential that haven’t come public… until now.
The growth of the SPAC market as an alternative to the traditional IPO gives these firms the opportunity to go public in an investor- and company-friendly manner.
This is an area where a company’s big earnings potential can strongly correlate with big upside potential of its stock.
Ask yourself this question – would you rather make 10%, 100% or 1,000%? Of course, the answer is easy…
But remember that it’s much easier for stocks of smaller companies to go up 1,000% than those of bigger companies. It’s just basic math.
We can start with the fundamentals. Again, I believe that stock prices are generally tied to the earnings of a business.
If a company is earning $100 million of net income or $1 of EPS and it goes to $1 billion of net income or $10 of EPS – then that stock is going higher. Again, we ultimately don’t know the timing and magnitude of the stock move… but it’s going up.
Likewise, if that company’s market cap is $1 billion, then it needs $5 billion to $10 billion of incremental buying to go to a $10 billion market cap. Those are big numbers… but it’s doable.
Now look at huge companies like Facebook (FB), Alphabet (GOOGL), Amazon (AMZN), Microsoft (MSFT), and Apple (AAPL).
The average revenue of these companies is more than $200 billion, their average net income is more than $40 billion, and they have an average market cap of more than $1 trillion.
It’s going to be a lot harder for them to grow their revenue, earnings, and marketing by 10-fold from current levels.
To make big returns, you need to focus on companies that have opportunities to see big growth in their markets and earnings.
Today, this is the opportunity in SPACs – to get access to a group of great growth companies that have been increasing in size for a decade… but until now, they haven’t had a clear way to reach the public markets.
Editor’s note: Enrique says that SPACs are one biggest money-making opportunities he’s seen in his entire investing career. To learn more about this booming market – and to find out the name and ticker of a SPAC with 1,000% upside potential – click here. But don’t delay… this presentation (and the special offer that comes with it) is about to go offline forever.