If You Need To Love Stocks, You Got A Problem

Includes: CL, GE, JNJ, KO, PG, WFC
by: Tim McAleenan Jr.

In last month's Kiplinger Magazine, finance writer Anne Kates Smith wrote a compelling article titled "How To Learn To Love Stocks Again" that explained the virtue of making long-term stock investments (even at today's prices) and provided several anecdotes from investors that had been burned during the 2008-2009 and are now returning to the stock market. It is a good read, and you can check it out by clicking here.

While I agreed with all the statistics about the benefits of long-term investing that Ms. Smith cited, many of the personal anecdotes seemed to foreshadow trouble ahead. This investor's profile seemed to be a typical representation of the whole:

"Lou Horvath, a retail manager in Pembroke, Mass., is among those willing to give stocks another go. Horvath, 44, invested aggressively in stocks until the financial crisis cut his port­folio in half. "I pulled out and stayed out for three years," he says. But last fall, Horvath met Jeff Cutter, an adviser in Falmouth, Mass., who made him feel better about getting back into the market by recommending funds that aim to reduce volatility and risk by adjusting their exposure to stocks as their managers see fit. "I'd like to see how this goes, then reevaluate," says Horvath…"

While I hope the future works out well for Mr. Horvath, his attitude could possibly lead to a repeat of the misery he experienced in 2008-2009 the next time that a strong stock market correction strikes. The problem is that the personal anecdotes and the data presented by Ms. Smith speak solely in terms of stock price performance rather than the business performance of the assets owned, and I believe this focus can explain some of the misery experienced by investors.

Unless Mr. Horvath had a portfolio loaded up with financial stocks or cyclicals, then it is highly unlikely that the earnings performance of his portfolio fell by half during the 2008-2009 financial crisis, even though the net worth figure of the holdings happened to experience such a steep decline.

In particular, for blue-chip stocks, the earnings per share figures hardly budged. Coca-Cola (NYSE:KO) went from earning $1.51 per share in 2008 to $1.47 in 2009. Procter & Gamble (NYSE:PG) barely slipped from $3.64 to $3.58 per share. Johnson & Johnson (NYSE:JNJ) actually managed to increase its earnings per share from $4.57 to $4.63. And in the case of Colgate-Palmolive (NYSE:CL), the 2008-2009 transition turned out to be excellent as the firm increased earnings from $3.66 per share to $4.37.

I do not mention any of these facts to rag on Mr. Horvath. He lost half of his hard-earned wealth. He's already paid his price. Rather, my point is to encourage you to think about long-term strategies that actually have a decent chance of holding up. The personal anecdotes in the "How To Learn To Love Stocks Again" article solely associated investment success or failure with positive or negative changes in stock price. This can easily lead to investment strategy failure because it disregards the underlying business performance of the assets. A decent chunk of blue-chip stocks were churning out the same amount (or nearly the same amount of profits) in 2009 as they were in 2008, despite the steep decline in stock prices.

The problem with coaxing certain investors into "falling in love with stocks again" is that it teaches investors to equate rising stock prices with success and falling stock prices with failure (this is problematic because the time to make a killing in stocks is during a March 2009 environment, relative to a March 2013 general market environment). The whole premise of loving stocks as they rise is flawed. You generally get increasing amounts of value as stock prices decline, and there is little recognition that the investors that are wading back into the stock arena today realize that. Take this passage from Smith's article:

"It remains to be seen, however, whether the wave of investors returning to stocks will become a groundswell. The start of the year is seasonally strong for mutual funds as investors seed retirement accounts, and $41 billion doesn't go nearly far enough to erase the $548 billion that came out of stock funds between 2008 and 2012. Moreover, the next economic calamity, here or abroad, could send investors running for the exits again."

The last line there says it all. The next economic calamity could send investors running for the exits again. If followed, this is the action that explains why some investors get substandard returns. The time to buy is during 2008-2009 when Wells Fargo (NYSE:WFC) falls to $8 and General Electric (NYSE:GE) falls to $6. Value investors make their money by investing during bear markets. John Templeton bought $100 worth of every stock trading below $1 per share right after Germany invaded Poland in 1939 (while I don't think "stocks trading under $1" should substitute as shorthand for valuing a stock, the spirit of Templeton's actions still resonate).

If you experienced steep losses during the 2008-2009 crisis and are considering buying stocks again, the advice shouldn't be that "you need to learn to love stocks again." Rather, it should be that you need to craft a strategy that you can follow through the bad times. The only thing worse than doing something stupid is doing something stupid twice. If you sold out during 2008-2009, you need to first determine whether you can handle a strategy that encompasses large fluctuations in net worth on a year-to-year basis. While the returns from American stocks tend to outstrip alternatives such as bonds, real estate, and gold over long periods of time, that fact becomes meaningless if you cannot hold through the crisis years. The investor that steadily stockpiles gold coins will probably come out ahead compared to the stock investor that sells low. You have to know yourself.

That is why I would not recommend that investors need to learn to love stocks again. If you were a skittish investor in 2008-2009 and are considering returning now that the markets are rising, you may be poised to repeat the same mistake the next time a stock market correction arises. It does not matter whether stocks are a meaningful part of your wealth-building strategy as much as it matters whether you can craft a strategy that fits your personality and you can follow through all investing climates. Buying stocks today with the attitude of "I'll just see how it goes and then re-evaluate" sounds like the first step towards failure because it lacks the serious commitment necessary to persevere through the hard times. You should never force yourself into a particular asset class because it happens to be building wealth at a particular moment. The 10% annual stock market gains over the long-term can become a destructive mirage if you cannot handle the 30-40% periodic annual declines. Because if you cannot handle that, then "learning to love stocks again" may be the worst advice you could follow.

Disclosure: I am long GE, JNJ, PG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.