A Better Strategy At Hitting A Mega-Jackpot

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Includes: LUV, NFLX, NRG, NVDA
by: Jon Quast
Summary

The mania surrounding the now $1.6 billion lottery jackpot reminds me of my first lottery ticket purchase.

The odds of winning the jackpot through the lottery are improbable.

The odds of picking top stocks are much better, and offer jackpot-sized returns with considerably less risk.

"You got your lottery ticket yet?" This question was posed to me at the end of a long hot Friday as I was shutting down for the weekend. Working in construction for just above minimum wage always made me look forward to a couple days off. However, that particular day my buddies were abuzz with a swelling lottery jackpot, and asked me about my stance. I explained that even though that kind of cash would be life-changing, I believed it was basically impossible to win the lottery. "Well," one of them said, "you can't win if you don't play".

As cliche as that logic is, somehow it stuck with me that night as I got in my car. Maybe the heat had gotten to me. Maybe it was my hard work for little pay. Or maybe it was just the allure of what a lottery jackpot could mean for my financial independence. But somehow that logic worked on me. After all, it was only $1 to play at the time. That night on my way home from work I purchased my first ever lottery ticket.

And I lost.

Maybe you've been under a rock and haven't heard, but the Mega Millions lottery jackpot has surged past the $1.6 billion threshold. You looking for fame? CNN is reporting that you can be richer than Taylor Swift. You want fortune? Fox News has conveniently put together a list of what you can buy.

As we all know, playing the lottery is a gamble. A big gamble at that. The odds that you're going to hit this incredible jackpot are 1 in 302,575,350. But if $1.6 billion at those odds sounds appealing to you, then you should keep reading. You can actually do much better with stocks. Really.

The Improbability of the Lottery

Just how improbable are these odds? Jim Murphy from SportsBettingExperts.com has a great way to think about it.

"You have a significantly better statistical chance of getting struck by lightning in the morning, bitten by a shark at lunch and hit by a meteor before dinner while hitting a golf hole in one in the afternoon than you do winning the Mega Millions jackpot."

Ironically, you actually have higher odds of becoming a billionaire (1 in 770,000) than winning the $1.6 billion jackpot. Don't think too hard about this. It's kind of like the chicken and the egg.

But moving past the funny to the tragic, according to Business Insider, there are 10 states where residents spend on average over $300 annually on lottery tickets. Massachusetts tops the list at $767 annually on average. Many of those dollars are spent chasing improbable odds. In other words, people are clearly searching for a jackpot, but statistics show they won't find it in the lottery.

The Probability of the Stock Market

As someone who loves and recommends stocks, I often find myself talking to friends, family, and even strangers about investing. And people often express to me a belief that investing in the stock market is basically like gambling. But to me, nothing could be further from the truth. Consider this. Your odds of picking the best stock in the S&P 500 every year are 1 in 505 (there's actually 505 stocks in the S&P 500... not 500). In other words, those odds are over 600,000 times better than hitting the Mega Millions jackpot. For that reason, I almost take offense that what I call "investing" others call "gambling."

So let's have some fun. Out of curiosity, what would have happened if with some luck you picked the best stock in the S&P 500 every year for the last five years? Well, let's take a look.

In 2013, the best performing stock in the S&P 500 was Netflix (NFLX), up 298% for the year. It may be hard to remember back then, but Netflix didn't always have original content. That changed in 2012, but in 2013, the company released its first mega-hit in House of Cards. That year it also surpassed 40 million subscribers - more than HBO at the time. In other words, 2013 was the year Netflix transitioned from a newcomer to a heavyweight in its industry.

In 2014, the best-performing stock in the S&P 500 was Southwest Airlines (LUV), up 114% for the year. Looking back, I'm not sure you'll find much in this story other than solid execution and earnings beats. Cost per gallon of fuel - an important metric in the airline industry - dropped for the company for a third consecutive year to $2.93 per gallon.

In 2015, the best-performing stock in the S&P 500 was again Netflix, up another 134% that year. While revenue growth over 20% was surely a big part of why this performed so well, it was (and often is) subscriber growth that pushed the stock higher. The company outperformed analyst expectations in subscriber growth and nearly hit 80 million subscribers by year end. In other words, Netflix's subscribers doubled in just over two years.

In 2016, the best-performing stock in the S&P 500 was Nvidia (NVDA), up 227% for the year. This company had long been known for its core business of gaming GPUs, which continued to have strong results in 2016. But really it was the growth of Nvidia's datacenter and automotive revenue streams that fueled these enormous stock gains. Nvidia excels at positioning itself for upcoming trends, and 2016 was a great example of that.

And in 2017, the best-performing stock in the S&P 500 was NRG Energy (NRG), up 132% for the year. The majority of these gains came after the company's announcement of its "transformation plan". The transformation plan targeted lowering capital expenses, removing $13 billion in debt from the balance sheet, and selling billions in assets. But perhaps what got the stock moving fastest was management's commitment to deploy about $6 billion in cash through 2020, or about $20/share. Considering the stock was about $16.50/share at the time, that really turned investor heads and sent the stock higher for the year.

Now, if you had started with a $10,000 investment in Netflix in January of 2013, and reinvested those "winnings" every year into that next year's best stock, you'd be sitting on an amazing $1,511,988. How's that for a jackpot?

But maybe you scoff at the idea of finding spare cash for a $10,000 initial investment. Well, Massachusetts residents, if you went through this exact same process with the $767 you spend annually on lottery tickets, reinvesting "winnings" and adding a new $767 each year, you'd be sitting on a $166,321.70 jackpot right now. I'm betting (pun intended) around 99% of you aren't doing this well with the lottery.

Of course, the odds of picking the best stock in the S&P every year for five years aren't 1 in 505. Rather, it would be additive and rack up to 1 in 2,525. And while those odds are a paltry .04%, they still are light-years ahead of the lottery.

And we haven't even touched the biggest difference between investing and gambling. On the Mega Millions website under How to Play, the overall odds of winning a prize - any prize - are listed at 1 in 24. That means that you have a 96% chance of losing everything, and only a 4% chance of winning something... but probably just the $2 you spent on the ticket in the first place.

Contrast that with the S&P 500. You have low odds of picking the top stock for the year admittedly. But even just going for "average" with an index fund, you'd be up 16% per year over the last five. That $10,000 initial investment would be over $21,000 today. Oh, yeah, and your odds of losing it all during that time frame were 0%.

Conclusion

That hot Friday long ago tempted me with ridiculous odds for financial freedom. Thankfully, I was able to walk away from the lottery after only having lost a couple dollars. It would be later that same year that I would buy my first stock, enjoying much better odds than I ever knew was possible.

And while we are talking about odds, I'll mention I don't pick winning stocks 100% of the time. But I'm going to keep on picking stocks moving forward. Why? Well, let's just look at 2017 for simplicity. For 2017 the S&P 500 as a whole was up 21.7%. By my count, 386 of these stocks were up, and only 119 were down. But of the 386 that were up, 214 actually beat the average. In other words, my odds of making money were 76% vs. my odds of 24% of losing money. But my odds of losing all my money were 0% while my odds of beating the market average were 42%.

Those are odds I really like and why I continue to pick stocks moving forward. I believe it offers the best odds to hitting a mega-jackpot. Much better than the lottery.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.