Reflecting on some of my investments, it has occurred to me that investing success is as much about avoiding disaster as it is about picking winners. Let’s look at some examples.
My Biggest Loser
I have 6 companies in which I’ve invested that have dropped in value over 80%. Ouch!! Think about that. Let’s say you believe in a company, you have a solid thesis, and you invest $10,000 of your hard earned dollars. An 80% drop means that you lost $8,000 and you’re left with $2,000. For me, that’s not an insignificant loss.
Lemonade
The company not the drink. Lemonade sells insurance. Yawn. However, they added a new wrinkle. Lemonade claims that it streamlines the process by automating many of the steps involved in gathering information from claimants and processing reimbursement. And they use some of their savings to donate to charity. Pretty cool for an insurance company.
I read about them in 2020 and was intrigued. Then I got a pet insurance policy for Rosco. the sign-up process was simple and fully automated. The rates were lower than competitors.
Lemonade hadn’t gotten a ton of attention, at least not that I noticed, before I invested. After, they were everywhere. Lemonade was a media darling. It could do no wrong and the stock price shot up.
My Experience
Around this time, I had a claim for Rosco and I was surprised how labor intensive it was. I submitted through the app, but then the claim was assigned to a person. This person contacted me and asked for more info, then they contacted my vet. There were emails back and forth. This didn’t seem to be the automated process that I had expected.
Was My Thesis Broken?
I was certainly concerned. If Lemonade wasn’t able to automate claims successfully, they’d never be able to scale the business efficiently. But, I’m just one customer. I held on, but was watching closely. It certainly helped that the stock price kept going higher.
Let’s take a peek at the stock price chart.
I’m buying in late 2020, right before it shoots up from 70 to 160. My first purchase was at $51. It’s easy to rationalize a flaw in your thesis when the stock is on a tear, and the press is all positive.
The Chickens Come Home to Roost
2021 was rough. I hung in hoping for a turn-around. My thesis was in trouble, and I was holding on hoping that something would turn in Lemonade’s favor. In April of 2022, I lost hope and sold at an 80% loss.
It Wasn’t All Bad
I hedged my Lemonade bets a bit. I sold covered call options along the way and this helped bring my actual loss closer to 50%. So, it wasn’t all bad, but I’m calling the Lemonade experience a huge disappointment, but not a disaster.
Why Not A Disaster?
What helped me avoid disaster? Most importantly, I invested a small percentage of my equity in Lemonade. My largest holdings by far are Amazon, Apple, and Netflix. Interestingly, my cost basis (what I’ve invested) is relatively low on each of these 3, they’ve just gained quite a bit over the years. One key to avoiding disaster is limiting the amount you invest in any one company. I also like to keep a large portion of my equity investment in low-cost S&P 500 funds. This helps me avoid disaster.
Growth Stocks are Risky
Growth stocks are not guaranteed to grow. They’re called growth stocks because their company business model relies on sustained high rates of growth. Early on, when Lemonade was growing its customer base rapidly and was getting into new insurance lines, it was a growth darling. Later on, when it’s insurance loss levels were higher than competitors, there was question whether the business would be able to scale to handle all of that growth profitably. Growth stocks pop when news is good, but can drop significantly when things turn.
Diversify
I currently hold 34 growth stocks in my portfolio. I expect some will succeed like Amazon, Apple, and Netflix, but I also know some will struggle like Lemonade. Investing in several companies and keeping your investment in each small can help avoid disaster.
Another Close Call – Realty Income
I retired in December 2019, so in early 2020, I was continuing to invest in growth companies – like our friend Lemonade, but I was paring back some large equity growth company positions, taking some gains and moving to income stocks. My rationale was that since I was no longer getting a salary, I needed a stream of income from stock dividends.
After some research, I invested heavily in Realty Income, ticker: O. Realty Income is a net lease company, which means it passes on a lot of costs to its tenants. It had very stable tenants like 7-eleven and Walgreens, and it paid a solid 4+% dividend that it has increased 124 times. Realty Income is known as the monthly dividend company. Most companies pay a dividend quarterly, but the dividend is such a big part of its business, Realty Income pays monthly.
This is just what I needed. Instead of taking a nibble, buying a few shares and watching, I went all-in.
Recipe for Disaster
This is the first time I had ever made a bet that large on 1 company. My rationale, along with it being a solid company with a long track record of success, was that the dividend alone would make it worthwhile. Who doesn’t love a dividend payment every month?
Realty Income is a Real Estate Investment Trust (REIT). We won’t go into the details of REITs today, but essentially they are companies that own properties (or sometimes mortgages) and lease them to tenants. They pay out most of their income to shareholders in the form of a dividend.
Unfortunately, I went all-in just before 2 unfortunate events.
- The COVID pandemic. Lots of people stayed home. Not got for a company that owns properties.
- Rising interest rates. A 4+% dividend looks great when treasuries and high yield savings accounts are paying less than 1% APR. When treasuries and high yield savings accounts are paying 5%, investors prefer them to the risk they’d need to take with a stock that pays the same annual percentage rate.
Because of 1 & 2, Realty income went from $77.54 per share when I bought, to $51.35 per share today. That’s a 33% loss. It’s not 80% like Lemonade, but because I invested a big chunk of capital all at once, at a really unfortunate time, the dollar loss I incurred on the 33% drop on Realty Income was greater than my dollar loss on Lemonade. Gasp!
I Held On
My thesis largely holds true. I wasn’t prepared for Covid and rising interest rates, but I still like the company. And while a 33% loss is a kick in the pants, don’t forget the dividend. With the combined monthly dividend payments that I’ve earned and reinvested over the past 4 years, I am only down 14%. It still hurts, but quite a bit less.
Avoid Disaster
A long and winding road…let’s get back to the point. As investors, we rely on investments like Apple, Amazon, Netflix, or a good low-cost S&P 500 index fund to grow significantly over time. Read more in the post on compounding.
But the other side of this is that we need to protect ourselves against disaster. In the examples above with Lemonade and Realty income, I was able to avoid disaster. I assure you I felt pain, but it was not a disaster. Let’s review why.
Limiting Exposure & Diversification
We never know what an investment will do. We can get an indication from historical data and from annual and quarterly reports, but we never really know. This is true for Lemonade and Realty Income, it was also true for Enron and long-term treasuries.
If we invest for a long enough period of time, we will all find ourselves in the position where our investment loses 50%, 80% or even 90%. Don’t put all of your eggs in 1 basket. Diversify.
Dividends Help
In the case of Realty Income, earning a 4+% annual dividend made the difference between a 33% loss and a 14% loss. You may choose to take your dividends in cash to fund your spending, or reinvest them in the underlying security if you are bullish on the company’s future. Either way, you’re being compensated.
Dollar Cost Averaging
Dollar Cost Averaging is a technique for making smaller purchases over a period of time to avoid buying all of your shares at a high point (like I did with Realty Income). My typical approach to investing in a new company is to buy a little, start watching and reading, and buy a little more – sometimes when the stock pulls back and goes “on sale”, sometimes I may buy more as the stock price continues to grow. I did not do this on Realty Income and I paid the price. While it was not disastrous, it was more painful than it should have been. If I had spaced my purchases out every 3 months or so, I would be in a much better position today.
Summary
As investors, we will make mistakes. Investing success is as much about minimizing the impact of mistakes as it is about finding great long term investments. Diversification, dividends and dollar cost averaging can help us lessen the impact of our mistakes on our overall portfolio.
Thanks for reading. Let me know your thoughts.