Get Poor Quickly!

One of the best ways to measure how much luck is involved in the outcome of any competitive event is to ask how easy it would be to lose that event on purpose[i]. It would be very easy, for example, to lose a round of golf or a tennis match on purpose—implying that skill determines the outcomes in those sports, not luck. But what about investing? Here, the answer is less certain. Just as it’s hard to consistently pick stocks that beat the market, it is also difficult to consistently pick those that lose to the market.

But here is one strategy that you could have used to lose on purpose with great consistency over the past 50 years[ii]: every year, buy the 25 large cap stocks[iii] with the most expensive EBITDA-to-Enterprise-Value ratios and hold for one year. Rinse and repeat for 50 years.

If you had done so, you’d have lost money more often than the market (these stocks went down in 35% of 12-month periods, vs. just 24% for all large stocks), you’d have performed considerably worse overall than the market (5.6% annualized returns vs. 10.5% for all large stocks), and you’d have lived through a much more volatile ride (24.7% annual volatility vs. 15.9% for the market).

Here is the hard part. Many of the worst current offenders have been featured on 60 Minutes. They ignite our imaginations. They are damn exciting. Hidden within this list of 25 may be the next Google or the next Apple. The list includes Twitter, Tesla, Alibaba, and GoPro, to name just a few.

Still not convinced that buying these expensive stocks is a bad idea? This strategy of buying the most expensive stocks has underperformed the rest of the market in 87% of five year periods and 95% of 10 year periods. Would you play any game that had those odds? Investors do all the time.

The message here is pretty clear: Don’t buy expensive stocks. DON’T BUY EXPENSIVE STOCKS. DON’T BUY EXPENSIVE STOCKS!

That is unless you want to increase the odds of getting poor quickly.


[i] Michael Mauboussin explores this idea in depth in his great book The Success Equation

[ii] Starting in January of 1964 through June 2014

[iii] Those with market caps larger than the entire universe’s average, today that would mean a floor of roughly $7B