Wild stallions

I have long believed that a smart investor who

a) understands what makes companies thrive or fail
b) understands each stock’s current valuation

can succeed more often than not predicting which stocks will beat the market.

I would now put it somewhat differently

I now believe that a smart investor who

a) understands what makes companies thrive or fail
b) understands that stock valuation can fluctuate remarkably

can succeed more often than not predicting which stocks will beat the market.

A brief recap

One of my biggest investing mistakes to date was trimming my Shopify position from 25% in the beginning of 2017 to only 6% by the end of March. To be fair, the stock was up from $43 to $68 per share. At the time, I thought that was more improvement than I could possibly have hoped for.

What I learned as Shopify went on to $120 in the next several months, then down to under $90, now up to almost $130…is that stocks, wait for it, can be volatile.

Yes, I’m not a complete idiot. I knew that stocks, especially stocks like Shopify, vary higher and lower by a much larger percentage than a stock like Johnson & Johnson or Disney or Coca-Cola. But the volatility concept only explains half of the picture. Yes, when the market goes up, Shopify will go up more, and when the market goes down, Shopify will go down more. But the other half of the picture is market sentiment on the specific company.

It’s not all PS ratio, PE ratio, etc.

In early 2015 Bed Bath and Beyond (BBBY) shares went for about $75. The PE was high-teens, very reasonable. It appeared a stodgy, boring company…and that expectation has proven correct. Revenue today is within 10% of where revenue was then. EPS is too. But the PE is now ~6.5 and the stock trades for only $23 (less than a third of it’s price 3 years ago). The most significant thing that happened is that the market decided the company was going downhill. This effect is 10x stronger than the degree to which the company results have (so far) actually gone downhill. BBBY looks in every respect like the same boring company.

Conclusion

If I were simply to conclude that the market prices stocks based on expectations rather than results, I would not blame you for thinking your time largely wasted in reading this post. To me, the lesson goes far beyond this. The lesson is to realize that we get lulled to sleep. If I had done a poll in early 2015 and asked everyone to predict whether the BBBY share price would rise or fall 3x or more by early 2018, how many people would have thought this stable, boring company would have that drastic of a run? I wouldn’t have believed it. If you told me that revenue and EPS would be roughly the same, I REALLY wouldn’t have believed it.

Likewise, I wouldn’t have believed Shopify would be over $120 just nine months after I loaded up on it at $43. Even though I liked it enough to allocate 25% to it, those results were not on the chart of my possible expectations.

Same thing with Arista when Saul was buying below $80 a share just over a year ago. I might have said, “Maybe he’s right…maybe it will double in a few years.” Well, it more than tripled in just over a year.

This post is a long-winded way of saying that the market doesn’t just change its mind slowly or predictably. Sometimes it changes its mind in multiples of its former sentiment. Sometimes it decides a company is not worth a few billion, but 20 billion, and it does so over the course of a matter of months.

Market sentiment is not tame and predictable. Market sentiment is a fury. And stocks are wild stallions. Their valuations will not succumb to your expectations, nor mine.

Pick good companies. Strap in for the ride. That is our one and only advantage.

Bear

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This post is a long-winded way of saying that the market doesn’t just change its mind slowly or predictably. Sometimes it changes its mind in multiples of its former sentiment. Sometimes it decides a company is not worth a few billion, but 20 billion, and it does so over the course of a matter of months. Market sentiment is not tame and predictable. Market sentiment is a fury. And stocks are wild stallions. Their valuations will not succumb to your expectations, nor mine. Pick good companies. Strap in for the ride. That is our one and only advantage.

Thanks Bear, for a nice thoughtful post. A subsidiary lesson you can pull out of your experience is don’t sell your position in a stock just because it has gone up (I was still adding to my Shopify at $60, and I had held it since $27 or so). If it is getting to be too large a piece of your portfolio, or if its rise makes you really uncomfortable, sell 5% of it, or 10%, but not 75% unless you have a good reason besides price. (They tell people never to short a stock just because it’s gone up, because you never know how high it can go).

Best,

Saul

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Thanks Bear. I struggle with this question everyday. Clearly market sentiment has been with us for the better part of a year - at least in regard to “Saul stocks” - with the exception of December 2017, when for temporary and predictable reasons sentiment partially abandoned our high-flyers. No doubt sentiment remains with us now, but what will it take to change that? Will we see it coming? Will we correctly identify it when it does? What would it take for value stocks or high dividend stocks to gain favor? I realize that in theory there are deep rooted economic trends and factors that will dictate the answers to those questions, but it’s, as you say, the “multiple” and “speed” of reversal that worries me. It’s not likely to be gradual when it happens.

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with the exception of December 2017, when for temporary and predictable reasons sentiment partially abandoned our high-flyers.

Year-end profit taking/locking in or are you thinking of other reasons?

Exactly. Nothing at all had changed and there wasnt a perceptible change in sentiment. At the time I sat tight as most here did. I just wonder if we’ll know/feel when sentiment turns for more seriously. I think Bear correctly identified the problem as one of degrees.

And stocks are wild stallions. Their valuations will not succumb to your expectations, nor mine.

Pick good companies. Strap in for the ride. That is our one and only advantage.

Bear:

IMO, you are making observations about the volatility of some high beta stocks but otherwise, this is not an “advantage”.

The general market did amazingly well…the NAS was up around 28% in 2017…all high tech stocks with high beta’s were going to do well regardless so sure…if you knew this would be an amazing year in techs, strap in.

But what if the tables were turned and the market went the other way…you would have been better off not being strapped in.

Point being that many of the stocks that have done so well in 2017, were small, high revenue growth but often very little or no earnings…they are the stallions…you selected them as such…not the mudders, plodders, dividends, etc that just plod along making money over time.

Don’t worry about SHOP…worry about your next deployment and why. Saul does this better than most…trying things on and jettisoning what he doesn’t like…he has been wrong about some he jettisoned but so what…he is constantly looking forward and that IMO…is the winning mindset…different from you perhaps,I would argue “don’t get locked in”…ever…always look for your next great investment.

Being out of SHOP did NOT mean there wasn’t money to be made elsewhere…obviously there was money being made all over the place.

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What I want to be in are stocks with sufficient fundamentals that they will recover despite any market crash, and yet will be what wall street derisively calls “market darlings”. That means they cannot be in a bubble, and they cannot be a fringe company, they cannot be a plodder. They have to be the best at what they do with competitive advantages and growth prospects that are at the top 1% of all companies, even if not everyone realizes that yet. They have to be disrupting things, and will continue to disrupt things.

This is so, even if the market crashes, these stocks will recover. With my experience in the market, the best socks like this will come back if the world does not blow up. That is reducing risk by use of reasonable temporary defense mechanisms.

Don’t believe me, go back in time and pick and choose the best such stocks, watch them crash and watch them come back and lead the market with the strength of their fundamentals.

If the stock market has any rationality (debatable of course)just like in sports, the best of the best almost always resurge and demonstrate why they are the best, and the market recognizes this by the sure fact of pure, unadulterated, desire for naked profit and greed. A better mechanism one cannot find.

Tinker

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That should be temporal mechanisms. Dang auto correct! Temporal is a word!

Bear - where you say value, that’s price. Price can be driven by mood momentum sentiment.

b) understands that stock PRICE can fluctuate remarkably

In other words my valuation of BBY or SHOP would change if the narrative changes. so if I think of BBY as a declining business, I would not be tempted by low teens PE.

I really appreciate that there are such seasoned investors so willing to share their thoughts and experiences with those of us who don’t have nearly so much.

So, I understand the concepts of CAP and SAM. I realize that trying to time the market is futile. I know that strong companies will emerge from a downturn first and likely in a stronger competitive position (a greater CAP).

Tinker, are you saying you would/do pay no heed to sentiment or volatility? I realize that there are several waves of economic/technological changes/advances that many of the company’s favored by this board (and me) are riding. But, isn’t it also true that they are riding a wave of money coming into the greater tech sector chasing rising valuations - a “wind at our back” if you will. If so, wouldn’t it make sense to monitor sentiment at some macro level? Build a larger cash position in anticipation of a reversal? I wasn’t here in 2008, but I imagine many of you did just that.

Bear said, “sometimes it (the market) changes its mind in multiples of its former sentiment” which is clearly true. After having researched and selected strong companies with bright futures shouldn’t we also keep an eye on market sentiment?

I apologize if this is elementary but I really struggle with this. It seems Saul sometimes makes buy/sell decisions based on something more than a specific and identifiable change in a company’s outlook. Isn’t sentiment or something like it playing a roll in a decision based on nothing specific and material?

Thank you for entertaining my questions.

Market sentiment is not tame and predictable. Market sentiment is a fury. And stocks are wild stallions. Their valuations will not succumb to your expectations, nor mine.

Pick good companies. Strap in for the ride. That is our one and only advantage.

Bear

Yes, learning to stomach market volatility is the key to good investing. I also believe that picking good companies with a positive longer term outlook is the key. It’s difficult for an inexperienced investor since his/her convictions in their investment picks just aren’t as strong. Only now, after a couple decades of riding through two huge market crashes, am I able to identify quality longer term investments with good conviction. Then I buy and typically hold for many years and try to ignore the short term noise.

Diversification can be crucial as well since even the best investor might be right about a company only a little better than 50% of the time. For me, 25% is just too much to have in an individual stock - I never have that degree of confidence in a company. I’ve been wrong too many times. So I am much more diversified and sleep better at night.

dave

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Market sentiment is not tame and predictable. Market sentiment is a fury. And stocks are wild stallions. Their valuations will not succumb to your expectations, nor mine.

Pick good companies. Strap in for the ride. That is our one and only advantage.

Any one of us could have said in December, “This is the end of the ride! All our stocks are down big!” - And sold. And missed January…

Timing the market is awfully tricky. It’s enough for me to just try to find good companies.

Saul

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Bear - where you say value, that’s price. Price can be driven by mood momentum sentiment.

I couldn’t find the word “value” in Bear’s post. The closest I found was “valuation.”

Bear’s meaning is quite clear, that fundamental analysis by value investors is not all that useful in the market. In the early days of security analysis when bonds were investments and stocks speculation, it was easy enough to find the intrinsic value of bonds. The value of stocks is much more difficult to calculate or estimate because in addition to book value there is going concern value and growth value which are not directly measurable and depend entirely on the trader’s estimation.

Denny Schlesinger

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Pick good companies. Strap in for the ride. That is our one and only advantage.

Bear

In the SHOP example you used, one of the possible ways to let your winner run but limit your losses without using a stop-loss, is to hedge your position with PUT options. On a volatile stock like SHOP you might want to give it about a 20% cushion. For example, based on Friday’s closing price for SHOP at $129.07, you can buy the April $115 Put (~10%) for about $5, or the $105 Put (~20%) for about $2.75. so let’s say you bought at $90, you would have gained $39, which is > 43% gain. You can spend $2.75 and buy the April $105 Put (20% insurance policy). If SHOP drops below $105 by April you are assured you can sell your shares for $105, for a net gain of $12.25($105-($90+$2.75)). If the stock remains above $105 you lose the $2.75 you paid in premium, but you still have your shares, and you can let them run.

If you don’t mind capping your upside a bit, another way you can do this is with a Collar, where you sell a covered Call option as well as the long Put option. The premium from selling the Call helps to pay for your long Put option. For example, the April $160 Call pays about $2.50, so you can take the $2.50, and spend $2.75 to buy the $105 Put option, for a net $0.25 debit. With this strategy if the shares have climbed over $160 you can let the shares be assigned and exit at $160, or you can buy back the call at that time for the intrinsic value minus the $160 strike. At the same time you’re assured you can get at least $105 for your shares if it should decline below that.

In my case, I’m planning to use the second Collar strategy as my entry is at about $80. If my call is assigned I won’t be too upset with 100% gain. If it rolls back below $105 I’ll be glad I got out with a $25 gain. If it ends somewhere in between I’ll just do it again.

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Invest wisely my friends
CMFSoloFool - Ticker Guide / Share Holder
Profile and holdings: https://goo.gl/TYTU4S

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So, I understand the concepts of CAP and SAM. I realize that trying to time the market is futile. I know that strong companies will emerge from a downturn first and likely in a stronger competitive position (a greater CAP).

later

But, isn’t it also true that they are riding a wave of money coming into the greater tech sector chasing rising valuations - a “wind at our back” if you will. If so, wouldn’t it make sense to monitor sentiment at some macro level? Build a larger cash position in anticipation of a reversal?

You are contradicting yourself, first you say that “timing the market is futile” and later you propose timing the market, “Build a larger cash position in anticipation of a reversal?”

You need to resolve this contradiction in your mind, otherwise you can suffer whiplash. It is a difficult issue. I posted about it yesterday at the NPI board, not that I have a definite answer but one is not entirely in the dark either:

http://discussion.fool.com/i-am-not-as-concentrated-as-most-peop…

Denny Schlesinger

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NC,

To follow up on Denny, who was following up on your question. My answer involves a question first, how old are you? Because if you are nearing retirement, then you definitely do not want to invest like myself, and you want to start thinking about not investing like Saul as well. At that point in time you need to conserve capital because the temporal defense may no longer apply to you.

Now, if you are younger. Like OMG! This needs to be taught in schools, but it won’t be taught in schools, because then too many people would be self sufficient. If possible live with the 80/20 plan, which means live off 80%, save 20%, and put money into the best quality disruptive stocks (of the sort Saul invests in, and of the only sort I invest in (use the IBD Relative Strength Index and cross reference it with whatever hey call thei fundamental index, and find a universe of the best growth companies on Earth).

It may never happen again, and I did not know it at the time, but it turns out the two stocks that I settled into, NVDA and ANET, were #1 and #2 on these lists (though NVDA has fallen back to #5 a month or so ago, last time I looked. Don’t know how they presently rank). For me, it was the result of wanting the best to maximize my returns while limiting my risks. I also owned SHOP, and transferred all my SHOP into ANET, my reasoning was mostly because I just wanted to own more ANET when it was clear they had reached an inflection point (w 100 GB switches becoming the norm), but I also had some fundamental reasons that has been the subject of many threads. Mostly maes me feel good about it.

So I do not say never sell. As an example, QCOM. Still a dominant company. However, its dominanc was made in 3G wireless. I originally held it to an 8 bagger, and the only reason I sold it was because I needed money for Rambus (that was a historical trade back in my baby days, my first encounter with FUD), and then. After the market crash (for which I stupidly did not sell. More later on this) I bought QCOM again because it had gotten ridiculously undervalued and it became a triple over the next 3 years. That was half my port at the time. ARMH was the other half. Two minimal risk companies fundamentally with big upsides.

Anyways, QCOM is still a great company. But when 3G growth ended, it was clear so would the growth of Qualcomm. So I sold it and never looked a back at it.

To make things shorter, there are two other reasons to sell other than you desperately or have a very compelling reason for the money, and those are disruption, and bubble.

Disruption happens all the time. The most clear cut and easy to demonstrate disruption was to AOL. That company was a monster. First laughed at for mailing tens if not hundreds of millions of floppy disks with AOL software on it for free. Then it grew to be the size of Microsoft, to the point that it bought Time Warner. It became AOL/Time Warner.

But you see, the executives at Time Warner (and I say this without bragging, it is just the truth that many of us understood - whereas much of what they understand is beyond us as well) is that broadband was coming. AOL was dial up, the world was going broadband. How was AOL suppose to stay dominant in the world of broadband?

Suffice it to say, Time Warner is again called Time Warner. It changed its name back within only a few years, as AOL’s fall was so fast.

Microsoft and Intel were disrupted by mobile internet, and so many examples of this.

The other is bubble. A bubble is when the marketcap has gotten so large that all the potential growth in the company, assuming things go great, is already priced into the stock.

E.g. Juniper networks, now valued at around $10 billion, leaped to a $50 billion marketcap. All projections of market size for it indicated, that YEP, that is just what Juniper will be valued at in 10 years, should all things come to fruition. So why bother even holding the stock! It was ridiculous.

I spotted these bubbles easily, but with naivety. I got out of such companies, but as I naive investor, did not understand everything going on. Hard learned lessons.

Oh yeah, fundamentals. Change.

Those are the reasons I have found to sell a stock.

Now as to market timing, some of the things like bubble and needing the money for some compelling reason are market timing. So that is relevant. But it has nothing to do with the market as a whole.

I’ve been at this since 1999. I have made so many amazing investments and caught so many bottoms that immediately soared thereafter, we jokingly called it the “Tinker” effect. But living life that way, and investing that way, unless it is your life, takes a toll. It requires intense commitment and focus. So I am trying not to do that anymore. If it is your job, great. But otherwise, timing like this gets in the way of life. Nevertheless, couldn’t help myself a few times as I got back in the market again. So yeah, I could still do it.

However, what I have found is, why? I am on my third decade of investing (alright less than 20 years, but 3 decades) and what I have found, illustrated so profoundly by ISRG, is through the internet bubble, 9/11, housing crunch, threee historical disasters, market collapse each of them, the companies that meet my criteria, that have not given a reason to sell, recover as sanity returns.

I bring up ISRG, because on NPI board we nit picked over it. It fell to about $95 or so, but we were putting in buy orders at $90. Never made it to $90. Guess waht it is selling for now? Yeah, 4 figures.

ISRG was one of the highest CAP factors in the market today, and it was just as high back then. But you know what, it never got cheap, never ever. It was always too expensive. Thus the importance of CAP and SAM over textbook valuations.

Examples like ISRG, for those special companies who meet these criteria, who have not hit the sell reasons, are numerous. Through thick and thin, disaster and pessimism, over time, returns from just holding these companies long, until such time as it is time to sell them, will far out perform trying to time the market.

In the past year, I recall two periods of time of panic. These lasted a few weeks each. Was that a time to sell?

In 2016 the SaaS stocks collapsed. I think it was in March or so of 2016. I had other things going on at the time and was not looking at the market then. So I don’t know why. Was that time to sell?

Sure the housing crash was time to sell, but how to know? In the end, just holding and buying more, systematically each month, and you will have killed the market, and minimized your risk, and minimized your stress, and minimized your tax bill (do not poo poo taxes).

So this has gone on too long, but I of course love to discuss the topic. The world today is full of systems. Systems such that even after the Great Depression, the best companies gave a great return if you could have held that long, even at the top. W.W. II was not the end of the market. The 1970s malaise was not the end. And these systems are even stronger and smarter now. It will take a destruction of modern civilization to destroy our economic systems. And if that happens, we will have much bigger things to worry about (that is what I thought about after 9/11, when I sold nothing and saw things collapsing to what I thought might be zero).

Thus the investment philosophy that I have returned to the market with. Fortuitously during a great bull market. But I also held 3 of the highest return non-biotechs, so I will take some credit for taking advantage of the circumstances.

Fortunately, these circumstances were (and currently are) supported by fundamentals. Thus I feel good about what I currently hold.

In the end, I will do better with the above philosophy than I will do by selling in and out to try and time things beyond the system described above.

And with that, I apologize for length and being so convoluted. I obviously need a beer.

Tinker

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Saul and Tinker understood my main points and reiterated them well:

  1. Don’t sell based on valuation. Trim if you have to, but don’t completely resize a position simply because you think it’s “expensive.”

  2. Seek quality: there’s no safety in “value” (as I attempted to point out with BBBY).

Pick good companies. Strap in for the ride. That is our one and only advantage.

Again, the point here was that we cannot time anything. When I started selling Shopify in early 2017, the PS ratio was 14 or 15. It was maybe 16 by the time I got down to a 6% allocation. It has been as high as 22. I would be a lowercase fool to say it couldn’t go to 30. There’s. just. no. telling.

If you sell XXX because it’s expensive…
You will not necessarily be able to get back in cheaper. It may never be cheap again.
You will not necessarily find another stock that’s at a lower PS ratio that shoots up like XXX.

A couple of responses

I just wonder if we’ll know/feel when sentiment turns for more seriously.
and
After having researched and selected strong companies with bright futures shouldn’t we also keep an eye on market sentiment?

Steve, we won’t know. Things seem expensive now. They also did in 2013. When will you know? That’s my point. Don’t try to time anything. Arista, Shopify, all of them will fall precipitously at some point. You and I and everyone else won’t know when. But:

  1. How much more will they be worth by then?
  2. My belief is that they will come back – if the businesses keep performing like they have, how could they not?

That said, I’ll be the last to blame you for building up a little cash position. I too have sold and trimmed some things lately, and haven’t found an obvious place to redeploy. I’m dabbling in options after I joined Stock Advisor thanks to some folks here who answered my inquiry about options discussions. (Tom Gardner, if you’re listening, you’ve probably gotten several subscriptions because of Saul’s board, esp to SA and RB.) Anyhoo, the SA options board is as active as I’d been told, and I have joined in the discussion. Here’s a link for any SA members interested: http://boards.fool.com/1081/twilio-my-first-long-call-329605…

Rather than buy 100 more shares of XXX or YYY, I figure I can limit my exposure by buying call contracts. Anyway, that’s enough here, as this is not the board for options talk. Come join us on SA options if you’re interested.

But what if the tables were turned and the market went the other way…you would have been better off not being strapped in.

Duma, because it is unknowable whether you are strapping in at the end of the bull run or in the middle, that is why I say: picking good companies is our only advantage. As Tinker points out, they should rebound faster. That is obviously because in a bear market their company results should eventually overcome market bearishness.

Another way of stating what I meant to say in the original post is that stock performance should eventually mirror company results. This may happen now – I may get a quick 200% on a holding and then it may level out for a while (like Square). Or the stock may level out for seemingly forever (like Wix) only to take off later, as the continued good company results eventually force the market’s hand.

Bear

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Duma, because it is unknowable whether you are strapping in at the end of the bull run or in the middle, that is why I say: picking good companies is our only advantage. As Tinker points out, they should rebound faster. That is obviously because in a bear market their company results should eventually overcome market bearishness.

Hey Bear:

Promise, my last comment. I think you are being too hard on yourself about SHOP and using this “anomaly” of a stock (massive high P/S) to determine an investment thesis for all stocks and all conditions going forward.

I have already presented data on how RARE a sustained high P/S stock is year after year after year…those are pretty factual to this discussion.

Or how about the fact that all those people that held on to their “great companies” with the YsK crash…took 17 years to get whole!!! 17 long painful years…

You did great last year…enjoy that…you made some good decisions…revel in that…none of us will ever make perfect decisions…accept that.

Best:
Duma

PS…I also exited SHOP after a 4 multiple…redeployed elsewhere for a 50% gain and then…you guessed, right back in SHOP…was I wrong…don’t know yet

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I think you are being too hard on yourself about SHOP…

“Should have” (buyers/sellers remorse) is a terrible emotion to have in the market. Some people say never to look back, I disagree, learn from your mistakes but take the emotion out of it, it’s just another day in the market.

If I may be permitted a personal anecdote, I used to sell insurance. In sales school they taught us not to waste time, if you don’t close the sale by the second visit you should move on and you probably will close one of three prospects. Back in the office colleagues would ask:

Q “How did it go?”
A “Great!”
Q “What did you sell?”
A “Nothing.”
Q “What’s so good about that?”
A (with a smile on my face) “I only have one more ‘No’ to go before my next ‘Yes!’”

It’s a question of attitude, train yourself!

Denny Schlesinger

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Pick good companies. Strap in for the ride. That is our one and only advantage.

Investor behavior is interesting to observe. I believe most investors make investing way too hard, and that it’s really quite easy to ‘beat the market’, especially using some of the resources at TMF. Here’s an example, with my returns, of our one and only advantage…

AMZN 70,000%
AAPL 805%
NFLX 2,575%
GOOG 410%
IPGP 2,400%
PCLN 975%
ATVI 540%
UNH 650%
BRK-B 200%
BOFI 152%
HAS 250%
COST 220%
EXEL 600%
BLX 190%
SBUX 180%
ISRG 185%
SYY 200%
ULTA 185%
WM 180%
PFE 250%

With the exception of AMZN ('97 purchase), all of these are less than 5-9 years old. No taxes paid in capital gains, no work following them beyond a casual look via TMF, no glued to a computer screen following the stock market. I hold 55 stocks and the vast majority of others are well over 100% return in same time frame, and a small handful of insignificant losers (key word hold). The Great Recession really helped :slight_smile:

conifer

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