My Lessons Learned in 2016, Warts and All, Could Help You in 2017

 | Jan 09, 2017 | 11:00 AM EST
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In 2016 I spent a lot of time researching, investigating and just thinking about what does and does not work in the stock market for individual investors. It always has been a topic of interest, but this year I dug a little deeper and quantified a few things that I long suspected. I also made few discoveries that surprised me a bit and hopefully will make me a better investor. I plan to continue this expanded research process in 2017, but I thought I might share some of the more significant discoveries of 2016. I have talked about some of them, but it might be useful to have them all in one place.

I always have talked about buying when markets are down and using a Womackian approach as one of the best ways to approach the market. Not only does testing bear that out, but it is evident when you run the numbers that the best way to build a fortune in the stock market is to conserve cash and have huge cash balance when the market inevitably goes into free fall.

Every value strategy that I tested has remarkable outperformance following a significant decline that then begins to revert to the mean. Testing a "buy in the crash" approach using blue chips and even index funds also shows great returns. It is bumpy and it is scary at times, but if you want to get rich in stocks build huge cash reserves and wait.

A significant market decline also creates the opportunity to buy your 100-to-1 stock in sectors such as robotics and cyber security. When prices drop the air will come out of the valuations of these companies and it will be a lot easier for value types such as me to pull the trigger. We always should be thinking about which sectors offer the potential for 100-to-1 returns but buy them when it the market holds a sale.

I always have been a rigid deep-value asset-based investor, and it has worked out more than OK for me, but the same research effort shows me that my rigid thinking has cost me money. The massive outperformance of deep value begins to fade and eventually lags the market after about three years from the eventual market bottom. I will be doing more work on this in 2017, but the optimal strategy appears to be using deep Graham-style value following a crash and switching to an approach such as the Enterprise Growth and Income portfolio after about three years or so.

You probably do not own enough community bank stocks. Indeed, if you are like most individual investors you do not own any. In normal times they are compound return machines, and after a collapse in banking buying sound financial institutions at a fraction of book value will earn returns that would make the most brazen hedge fund manager blush. Best of all, problems in the community bank sector can be seen developing from miles away. If your keep track of price to book value ratios in the industry as well as nonperforming asset levels and loan delinquency rates, the times to hedge your risks or scale back your positions are easy to see.

I have done well with small bank stock over my career, but I have made one major mistake that has cost me an enormous amount of money. When one of my banks has been taken over by a larger institution that trades at a high multiple of book I have sold the shares and moved on. After lengthy discussions with John Allison, chairman of Home BancShares (HOMB) , and reviewing the data I found that this is a mistake. If the buyer of your bank is a smart buyer and has a high earnings growth rate, a low-efficiency ratio and a reasonable price/earnings multiple it would have been a far better idea to hold the shares of the acquiring bank. The stock price of a smart buyer such as Home Bancshares and Bank of the Ozarks (OZRK) with a history of smart deal-making can rise a lot farther over time than I ever realized.

I have talked this last one to death, but the simple fact is that you probably do not own enough real estate. Equity REITs have outperformed every asset class since 1972 except small-cap stocks. On a risk-adjusted basis they have crushed every single asset class by a significant margin. Buying REITs at low multiples, cash flow and asset value and then reinvesting the dividends is a fantastic wealth-building strategy and one that most people seem to overlook. Given that REITs should be able to grow their payout over time, income investors should own a lot of REITs as well for both income and inflation protection.

I learned a lot in 2016 and hoped to continue to do so in 2017. As always, I will share the conclusions and lesson on Real Money even when the results pop one of my favorite balloons.

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