The Joys of Compounding: The Passionate Pursuit of Lifelong Learning, Revised and Updated (Heilbrunn Center for Graham & Dodd Investing Series)

by Gautam Baid

As a bull market matures, many investors tend to move their portfolios from high-quality stocks with steady growth and high return on equity to cheaper but higher-growth stocks with poor management quality and inferior return ratios, and then to commodities and cyclicals, and then to turnaround situations that are currently loss-making, and then to microcaps with limited track records of operations, and finally to highly leveraged companies with projections of rapid revenue growth. At this point, the bull market usually tops out, and at the end of the euphoric phase, most investor portfolios have only junk left in them. (Only when the tide goes out do you discover who’s been swimming in momentum.) During the bear market that follows, both quality and junk stocks fall hard. The former eventually bounce back in the subsequent recovery, whereas the latter stay low for many years, until the next bull run takes over. Only after going through the pain of a couple of such cycles can an investor resist the incessant urge to move down the quality ladder and chase quicker returns. The greatest learnings always come from a bear market, and these lessons bear fruits for an entire lifetime.