Have you ever heard of the term “torpedo stocks”?
If you’re currently saving for retirement by buying stocks, this is a term that you should definitely be familiar with.
In my last article on Modest Money, I discussed the pitfalls of index fund investing. In my view, index funds are likely to lead to pain, rather than a comfy lifestyle in retirement. That’s contrarian thinking sparked by incredibly high market levels entering 2018.
But I also mentioned a second path to retirement bliss, one that’s much more likely to work out if you are prepared to put just a little bit of time and effort into your portfolio — deep value investing.
You’re Probably Investing The Wrong Way
In my view, most people who are selecting stocks for their retirement are doing it wrong. Most investors are picking “good companies,” stocks that have gone up a lot in the past, stocks of companies that are soon to release higher earnings, or stocks that have been selected because the technicals look good. All of these make for lousy long term investments.
Take “good companies,” for example. I remember once discussing investing with someone on a Google forum years ago. He was bragging about how he bought Coca-Cola and how great of a company it was. He had held it for 10 years which, at the time, meant he bought it in 1998 or 1999. Looking at the chart it was easy to see that the company’s stock price had dropped meaningfully since then and had only crept back to and passed his breakeven cost 10 years later. He had made a compound annual 3%. That performance will not make for a great retirement.
The problem wasn’t the company, it was the valuation. Coke was widely regarded as one of the world’s best companies but it was trading at an enormously high PE of 61x. Put another way, if you bought the entire company it would have taken you 61 years to earn your money back on the investment.
Coca-Cola, one of the best companies of all time, produced terrible returns for investors. (Source: http://latticework.com/valuation-matters-coca-cola/)
Valuation is key when it comes to investing. And, while the above scenario is bad, torpedo stocks are even worse. A torpedo stock is a rapidly growing stock that ends up devastating investors. These stocks always have a very positive consensus view leading up to the devastation — both pundits and investors think the stock and the company are going to keep on growing rapidly. But, some hiccup in earnings or negative event occurs that disrupts that growth trajectory, leading to a massive drop in price.