Welcome to the second chapter of my journey in the Stock Market. As a quick recap of the first part of my stock market journey, we are in February 2019. I have just been through my first significant downturn of the market, and I have not enjoyed it much.
Between October and December 2018, the index S&P500 dropped 20%, dragging my funds with it. At the end of December S&P500 began to raise, and by the end of January 2019 it had grown 17% (in just 6 weeks).
After seeing this behaviour, and having accumulated a 10% annual return on my S&P500 Index Fund during 3 years, I was determined to learn more. My friend Sergio recommended me the book “Rich Dad, Poor Dad“. I realised that the best way to learn about investing in stocks was not on internet, but on the books.
Stock Market Learning Phase – Books
After some research on the “best books for stocks”, I got an initial list:
- The Intelligent Investor – Benjamin Graham
- The essays of Warren Buffet – Lawrence Cunningham
- One up on Wall Street – Peter Lynch
- Beating the street – Peter Lynch
I bought all four on Amazon and the stock market journey continued. If you are looking for a way to learn how the stock market works, I highly recommend all of them except “the essays of Warren Buffet”. Even if it is a good book, I didn’t find it as useful as the others. Let me do a quick summary of my two favourites.
The Intelligent Investor – Benjamin Graham
This was the first book I read about finances, and I can tell you, the book is tough. It was like going back to university, only 10 years later and with my brain not in a good shape! I remember I had to stop every two pages to look up words, because I didn’t have any idea about half of them!
I was surprised because I had always been into finances. Also I had recently been reading a lot of information on internet, so I considered that I had the foundations. Well, The Intelligent Investor came to show me I was wrong 🙂 I am glad it did, because this was the book that changed my view on stocks forever
The book defines value investing, which focuses on generating steady long-term profits, highlighting the importance of ignoring the stock market moves and picking companies based on its intrinsic value.
- Analyse the long-term evolution of the company before investing
- Focus on steady and safe returns
- Reduce the risk by diversifying your investments
- The stock market is erratic, irrational and many times not correlated with financial fundamentals, you should ignore its moves
- Follow the dollar cost averaging investing strategy. Invest in the stock market every month the same amount, it doesn’t matter if it goes up or down
- Balance your portfolio between stocks (25%-75%) and bonds (25%-75%), depending on how expensive the stocks are (P/E ratio)
- Pick a stock that has a P/E * P/B ratio < 22.5
P/E is the ratio of the price of a stock divided by its earnings per share. P/E can tell you if a stock is expensive or cheap.
P/B is the result of dividing the price of a stock divided by its book value per share. Again, P/B can help you to identify if the share is overpriced.
Highlight of the book – Mr Market
There are so many brilliant ideas in this book that, if I started, I would never finish, so I am going to talk to you about Mr Market. Mr Market is described on the list above as point number 4. Benjamin Graham describes Mr Market as a person who comes to you house every day and quotes you different prices for the same stock.
Mr Market is not clever, very irrational, unpredictable, and his mood changes suddenly. He strongly suggests to avoid what Mr Market tells you, focusing instead on following your own strategy and doing your own research.
As you would have probably guessed by now, Mr Market represents the stock market, whose sudden and inexplicable swings should be ignored.
No wonder Warren Buffet considers it the best book about investing ever written. I mean, if Warren Buffet says that, you get the idea that it’s a good book.
When I finished reading it I was amazed by the amount of knowledge I had learnt in a short period of time. I re-read it again and made note of the pages with the most powerful ideas, so I could go back and read them whenever I needed it.
Earning money with the stock market is possible
At this point of my journey, I was convinced that earning money on the stock market was possible, and I was determined to do so. I took my first decision based on fundamental analysis, which was to sell one of my mutual funds. It was the Baillie Gifford American Class B – Accumulation, because I saw that the average P/E of their stocks was 50. That was more than 3 times the recommended maximum of 15 from Benjamin Graham.
I also did my own investigations on the S&P500 index, and I discovered that it had an average of 9% annual return over the past 150 years. If you pick a period of 10 years or more, it usually gives you an annual return of 10%. You can check it yourself on this S&P500 return calculator.
If we check the S&P500 Index evolution over the past 10 years, it’s really amazing. We started on 2009, at the end of the 2008 financial crisis, on 750. Ten years later, on 2019, we are at 3000. That means the value has multiplied by 4 in 10 years, which means a 15% annual growth.
It’s important to take into account that this huge growth has happened thanks to the value was very depressed on 2009 due to the financial crisis. But it does help to highlight the returns the stock market can give.
After finishing the book and analysing the S&P500 Index, I realised that obtaining a 10% annual return was not something extraordinary, it was the average! At that point I started to draw my strategy (I will talk about it on a later post), which included Mutual Funds, Index Funds and stocks picked by me.
I was eager to begin to pick my own stocks, but I knew I was not ready, not yet. I needed to learn more, so I embarked myself on the 2nd book of my stock market journey.
One up on Wall Street – Peter Lynch
Peter lynch is the former star manager of Fidelity’s multibillion-dollar Magellan Fund, where he averaged an annual 29% return from 1977 to 1990. 29% return during 13 years, it’s just unbelievable. If you had put 10 000 euros on 1977, by the end of 1990 you would have 280 000 euros. 28 times more, not bad right?
- Pay attention to the companies you run into in your day to day. This is the best way to find a good opportunity
- Invest in stocks with a P/E lower than its expected earnings growth
- No matter how good a company is, 50 P/E means it needs to grow 50% per year, that only leads to disaster
- Look for companies with low debt. A company without debt cannot go bankrupt
- Ask yourself how will you react if the market falls
- There are 6 types of companies: fast growers, stalwarts, slow growers, cyclical, turnaround and asset plays
- Fast growers and turnarounds are categories with very high reward, but also high risk
- Look for tenbaggers, stocks that grows ten times since you bought them
This book was very easy to read, overall after reading “The Intelligent Investor”. I had learnt most of the basic concepts already, and the narrative was easy to follow.
Highlight of the book – P/E to earnings ratio
Again, there are many things that I would like to point out, but in order to keep it short, the main thing I would like to highlight is the importance of comparing the P/E ratio and the earnings growth.
On the P/E ratio, Peter recommends to use the following criteria:
- P/E < 15 means the share is cheap. The lower the P/E the better.
- P/E > 20 indicates the company starts to be expensive. The higher the P/E the worse
Of course there are many more variables that need to be taken into account. I will go over them when I complete my post about my strategy to pick stocks.
Peter Lynch advocates for buying companies whose P/E is lower than its expected earnings growth. If a company’s P/E is 10, and its expected earnings growth is 20%, you have a good opportunity. The Price should double in order to have the same P/E than earnings growth, so you could have a big profit.
On the other hand, if a company’s P/E is 30, and its earnings rise 15% per year, investing on it is very risky. Sooner or later the price will have a correction in order for the P/E to match with the earnings growth, and for that to happen the price has to reduce 50%, which means a huge loss for you. Peter Lynch highlights the importance of taking into account always the P/E and the earnings growth when evaluating a stock.
Stock Strategy Inception
After I finished the book “Beating the street”, I decided that the reading phase of my stock market journey had successfully concluded. I designed a strategy based on the criteria of the three books I mentioned above. My main ideas were
- Portfolio divided by Mutual Funds, Index Funds and Personal shares
- Index fund will track the S&P500 Index, aiming to achieve the 9% annual return it had for the past 150 years
- Mutual funds will be picked based on its performance in the past 5 years. My target is to beat the S&P500 fund
- Personal stocks will have to comply with a defined criteria. My target is to outperform both S&P500 and mutual funds
My goal was to be able to identify stocks that perform better than the S&P500 index and the best mutual funds I could find. As you can see, I like to set ambitious targets, that motivates me to work hard to achieve them.
Currently my personal shares represent 37% of my stock portfolio, which shows you that I believe in my strategy. I will soon create a post explaining what is my criteria to pick a stock.
Where I am now
While I am writing the last chapter of my stock market journey, through the window I can see Autumn has clearly arrived. It’s October 2019, and I have the conviction that stocks are the best vehicle to accumulate wealth. Just by picking a low fee index fund that tracks the S&P500, and adding money every month, you can get a 9% return over the course of many years. Currently the Spanish banks give 0.1% in the savings account. I reckon getting 90 times more on your money is not bad, right?
During the first 8 months of 2019, I have achieved an astonishing 25% return on my stocks portfolio.
The main contributors have been the Mutual Funds and the S&P500 Index Fund. It’s important to highlight the outstanding performance of my personal seleted stocks, achieving a 12% growth in just 4 months.
If you want to check the analysis of my investments in detail, take a look at my November portfolio update.
Stock Market Journey Conclusions
Based on the deep analysis I have done this year, and on the results I am obtaining, I firmly believe that financial freedom is achievable, and stocks are the best investment to do so.
I do like to diversify, and that’s why I have been working on building a significant position on peer to peer lending. But still, I love stocks, and I like the challenge of picking mutual funds and stocks that will outperform the S&P500 Index.
Difficult? Yes, indeed. Impossible? Not at all, so I am willing to take that challenge!
Before wrapping up, I would like to show you how profitable can be to invest in the stock market. Please take a look at the below graph, which shows the performance of Lindsell Train Global Equity Class D investment fund. In 5 years it got a profit of 180%
I mean, we are talking about almost tripling your money in 5 years. If you want to learn more about investing in stocks, take a look at the article.
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