The EVA Monster Series: A Sip from Monster Beverage’s Flavor Empire

With this series, we’d like to give you some perspective on the companies in our distinguished EVA Monster universe. This rare breed of quality-growth stocks is worthy of your attention, and getting to know these businesses may pay off handsomely down the road.

As a quick recap, EVA Monsters have three things in common:

  • They earn high returns on the capital they employ.
  • They have growth opportunities that allow them to reinvest most of their cash flows at high rates of return.
  • They have a sustainable competitive advantage (that Warren Buffett calls “moat”), which prevents their competitors from taking away their extraordinary profitability.

These characteristics tend to result in a strong (double-digit) fundamental return potential, meaning that no valuation tailwind is necessary to get great investment results with EVA Monsters. (These case studies explain this pretty well.)

As Charlie Munger said:

“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns 6 percent on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6 percent return – even if you originally buy it at a huge discount. Conversely, if a business earns 18 percent on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”

We also shared the math proof of why buying EVA Monster stocks at a fairish valuation makes perfect sense for long-term investors. (Look for the “math example” in this post to alleviate your doubts.)

To round off the short introduction, we (1) try to avoid overpaying for EVA Monsters, (2) closely monitor the fundamental performance and management’s capital allocation decisions throughout our holding period, and (3) hold our positions as long as the underlying investment thesis remains intact, ideally for decades, to let compounding do the heavy lifting.

Without further ado, numbers prove that Monster Beverage (MNST), the best-in-class energy drink brand possesses true EVA Monster characteristics and is thus worthy of your close attention. As long as you agree with us that caffeinated beverages are not ripe for an inevitable downturn due to changes in consumer preferences, Monster could be a great addition to any quality-growth-focused portfolio.

Monster Beverage is one of the leading global players in the energy drink subsegment of the beverage industry, broadly regarded as Red Bull’s most significant competitor in the premium category. The firm relies on the Coca-Cola bottling system for production and distribution, as a byproduct of the beverage giant’s strategic investment to become Monster’s largest shareholder. The company was formerly known as Hansen Natural Corporation and changed its name to Monster Beverage Corporation in 2012.

The current leadership team has a more than respectable, lengthy background. The duo who originally led the consortium that purchased Monster’s predecessor entity is now mutually responsible for top-level decision-making (in a „co-CEO” structure). In our view, Rodney Sacks and Hilton Schlosberg have done an excellent job at creating and nurturing the premier brand image of Monster Energy, and their near-flawless execution was key to battling prominent rivals such as Red Bull.

The lion’s share of the firm’s revenue stems from its Monster Energy Drinks segment (92% of its fiscal 2022 sales). The company is responsible for the flavor development and branding of its flagship products, while the manufacturing and distribution processes are outsourced to the Coca-Cola bottling system globally.

Red Bull is broadly regarded as the creator of the energy drinks space in the early 80s, and it has remained the undisputed king of the category up until this day. The fact that the market leader stayed in private hands all the way speaks volumes about the profitability of the sector, as the firm was able to achieve this feat without relying on external shareholder capital.

Decades later, Monster emerged as the only viable competitor able to match Red Bull’s global reach, with the two forming an essential duopoly in the premium energy drinks space by now.

The firm is best described as a flavor and marketing powerhouse since it develops and manufactures the primary flavors for its flagship product lines in-house. Its ever-evolving palette ranges from traditional energy drinks to functional sports drinks, coffee, and tea derivatives, to its recently launched alcoholic beverage line. At the centerpiece of the company’s strategy is the flagship Monster brand, which certainly has a coolness factor to it, thanks to the company’s relentless marketing efforts.

Crucially, one of the most important components of Monster’s success formula is the strategic partnership with Coca-Cola, granting access to the beverage juggernaut’s global bottling and distribution network. This allows Monster’s new products to be scaled more quickly and eases retailer negotiations.

Thanks to its asset-light business model and pricing strength, the firm fares extremely favorably from a quantitative perspective, boasting enviable EVA Margin and ROC levels. Truth be told, we are finding it difficult to judge Monster’s moat from the qualitative aspect. If you believe that the energy drink category is here to stay (which we do), Monster undeniably has a sustainable competitive edge within the segment. However, compared to beverage titans such as Pepsi and Coke, the firm clearly plays in a lower league when it comes to scale and brand diversification.

Source: ISS EVA, The FALCON Method

As for the future, the global energy drinks market is estimated to grow at an 8%+ pace over this decade, fueled by humanity’s need for alternative sources of caffeine. Our back-of-the-napkin calculation revealed that even if we assume young adults in their 20s and 30s purchase all the energy drinks, it would still amount to roughly one can of Monster per week for the average U.S. consumer. This leaves plenty of room for organic volume increases, with pricing serving as a potential second growth lever.

Turning to capital allocation, the company boasts a reinvestment rate near 30%, and its capital-light nature allows it to achieve ROC figures constantly above 25%, which is more than respectable. A smaller portion of the money that’s being plowed back into the business goes toward organic reinvestments like advertising and flavor development, while the remainder is directed to bolt-on acquisitions aimed at diversifying Monster’s capabilities outside of energy drinks.

As for shareholder distributions, the firm has never paid a dividend and does not anticipate doing so in the foreseeable future. However, regular share repurchases are an important piece of the capital allocation puzzle, as Monster has cut its share count by nearly 8% over the past five years. On a sour note, the timing of buybacks signals very little opportunism, with the company regularly scooping up its shares at stretched valuation levels.

Looking at the stock’s valuation, Monster has always traded at a hefty premium to the market, and the current sentiment (albeit not ecstatic) still appears overly optimistic, even if we look at historical valuation figures. Please see below the valuation metrics of the EVA framework that remedy accounting distortions to give us a clearer picture of where the stock stands in a historical context.

(Curious why we don’t use the most popular multiples? Find out here!)

It is worth noting that 2022 has been the worst year for the company for a long time in terms of profitability, thanks to cost inflation and sourcing difficulties, but even after assuming a meaningful recovery in margins, the company’s NOPAT yield would still sit markedly below the market average (although its quality and growth characteristics might warrant a slight premium).

Overall, the time to get excited is not now. The “Key Data” table and the 5-year total return potential chart speak for themselves.

Source: ISS EVA, The FALCON Method

The FALCON Method can identify much better opportunities in the current market, so we are passing up on Monster for now.

The verdict

The “alternative” beverage market is extremely competitive and the barriers to entry are quite low, which means that Monster has to continuously fend off new brands to protect its superior position.

On the regulatory front, the supposedly negative health effects of regular energy drink consumption could lead to potential proposals that aim to restrict the sale and/or advertising of energy drinks below a specified age or to restrain the venues in which Monster’s products can be sold. We cannot exclude the risk that the energy drink sector might someday be scrutinized as much as tobacco, which could pose difficulties in marketing and distribution.

The growing presence of health consciousness might also translate to shifting consumer preferences, which could dampen the growth trajectory of energy drinks as we know them today, with more focus on nutritiousness and health benefits

All in all, while we have identified numerous risks surrounding Monster’s business, we would be happy to build a position at the appropriate price. The firm has an unquestionably strong brand, attractive market dynamics with plenty of room for international expansion, and a great leadership team at the helm. On top of that, Monster makes money from small, everyday repeat purchases, and this sector is also less prone to cyclicality and downtrading in tough economic times. Nevertheless, we would shoot for a smaller, 2-3% exposure with this name.

The company ranked 30th of our 59 EVA Monsters at the time of writing, based on its 5-year total return potential. (Businesses from 12 countries are represented on our EVA Monster list.)

It is safe to say that there are far more attractive EVA Monster stocks to buy in the current market, with the highest-ranking ten boasting total return potentials above 14% over our modeled 5-year timeframe. (You can always find the monthly Top 10 in the FALCON Method Newsletter along with our entry price recommendations.)

Want to learn more about our ranking methodology? Start with this blog post!

Winning by Not Losing

Imagine that you have a newspaper from one year into the future. The top 10 best-performing stocks from the prior year are on the front page of the paper. In addition, a large bank has stated that they will provide you with as much margin as you want with no interest charges. The question is: Assuming you start with $10,000, how much would you borrow to invest in these top 10 stocks? Allegedly, this is the question that Jim O’Shaughnessy, author of What Works on Wall Street, likes to propose to investors. Think about how you would answer before reading on.

Most people get this dreadfully wrong by saying something like, “knowing the winners in advance makes this a sure bet, so the best thing to do is borrow as much as possible and make the most of this lucky situation.” The truth is that you would go bust with such an approach. As Jim puts it, “Your problem is the margin. With $10,000 to start, if you borrowed millions, you would lose all of your equity. In fact, having a leverage ratio more than 4:1 ($30,000 borrowed) would have wiped you out in most years. It’s not a matter of if, but a matter of when.”

Although you are privileged to know that those ten stocks would give you an exceptional return by the end of the year, the problem is that hitting a bad patch of too many negative return days in a row (which is pretty normal) could wipe you out completely if you used excessive leverage. The moral of the story is that the path matters; in fact, the journey is more important than the destination. Knowing the winners’ names is not enough; you would also need to know the exact path that the stock price will travel throughout the year to make borrowing money a surefire solution to win big. Unsurprisingly, the more leverage you use, the higher the probability that you go broke, simply because even small declines in your portfolio wipe out your equity with larger amounts of leverage. It’s not rocket science. The point is that even knowing the future with 100% certainty wouldn’t make borrowing money safe, so given that we will never know the future with any degree of certainty, leverage is one of the most dangerous things you can do as a retail investor.

Even Ben Graham, the father of value investing, had to learn this the hard way. He established his investment partnership in 1926 and got off to a really promising start. Then came the Great Crash of 1929, and the fund was down 20 percent. Graham, however, was convinced that the worst was over, so he borrowed on margin and plunged back into the market. It was a terrible decision, and by 1932 the fund had lost 70 percent of its value. Graham was wiped out, forcing the family to leave its park-view duplex in the Beresford for a small rear apartment in the nearby El Dorado. His wife had to go back to work. As the famous quote attributed to Keynes says, “The market can stay irrational longer than you can stay solvent.”

This, of course, doesn’t mean that you cannot have an opinion on the economy or the stock market. You are absolutely entitled to have your own opinion, but you should still not let it affect your investment decisions. Confused? I’ll make it clear in a moment. One of the most famous value investors, Seth Klarman, summed up this approach nicely by saying, “One thing I want to emphasize is that, like any human being, we can discuss our view of the economy and the market. Fortunately for our clients, we don’t tend to operate based on the view. Our investment strategy is to invest bottom up, one stock at a time, based on price compared to value. And while we may have a macro view that things aren’t very good right now—which in fact we feel very strongly—we will put money to work regardless of that macro view if we find bargains. So tomorrow, if we found half a dozen bargains, we would invest all our cash.” It is always a good time to buy a high-quality stock that offers good value.

As a side note on holding cash or being 100% invested, what I learned at Columbia Business School’s Value Investing course is totally aligned with how I approached the question of cash management before and what Klarman emphasized above. Namely that cash should be the byproduct of a disciplined valuation approach. You end up holding a lot of cash when you review idea after idea and see nothing of interest. So, when you end up holding a lot of cash, that may be a good indicator that perhaps markets are a little bit too expensive.

At the FALCON Method, we buy the shares of companies that are out of favor. This approach is contrarian by nature, so you have to get used to buying stocks that are down and are still getting beaten up hard. There is simply no way to pick the bottom, and as Howard Marks writes, “I’ve never considered it a legitimate goal to say you’re going to invest at the bottom. There is no price other than zero that can’t be exceeded on the downside, so you can’t really know where the bottom is, other than in retrospect. That means you have to invest at other times. If you wait until the bottom has passed, when the dust has settled and uncertainty has been resolved, demand starts to outstrip supply and you end up competing with too many other buyers. So, if you can’t expect to buy at the bottom and it’s hard to buy on the way up after the bottom, that means you have to be willing to buy on the way down. It’s our job as value investors, whatever the asset class, to try to catch falling knives as skillfully as possible.” And then, this is what Seth Klarman suggests: “You must buy on the way down. There is far more volume on the way down than on the way back up and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.” (I hope those complaining about being down 10% with a stock realize that this is part and parcel of thoughtful investing. If you cannot accept temporary unrealized losses, then stock investing simply doesn’t fit you.)

Notice that even if you are an exceptional investor, the best you can do is pick quality companies where the stock price and intrinsic value seem to diverge (the price being the lower) and closely monitor the operating performance of those companies after investing. You may be right with most of your calls but certainly not all of them! Even the world’s best investors have names in their portfolios that are not winners. Nobody is right all the time. (By the way, anyone familiar with the calculation of expected value knows that the frequency of correctness does not matter; it is the magnitude of correctness that matters. Simply put, you can be a successful investor even if most of your calls turn out to be bad or mediocre as long as those few calls you get right are exceptionally profitable.)

Seriously, if you only take one piece of advice from this post, make it this one: Leverage works both ways and can easily derail your quest for financial independence. The more you use it, the less likely you are to reach your goal.

Want to learn more about our stock ranking methodology and evidence-based investment approach? Start with this blog post!
Or read more like this in the Beyond Dividends book.

The EVA Monster Series: A Formidable Membership Business in Disguise

With this series, we’d like to give you some perspective on the companies in our distinguished EVA Monster universe. This rare breed of quality-growth stocks is worthy of your attention, and getting to know these businesses may pay off handsomely down the road.

As a quick recap, EVA Monsters have three things in common:

  • They earn high returns on the capital they employ.
  • They have growth opportunities that allow them to reinvest most of their cash flows at high rates of return.
  • They have a sustainable competitive advantage (that Warren Buffett calls “moat”), which prevents their competitors from taking away their extraordinary profitability.

These characteristics tend to result in a strong (double-digit) fundamental return potential, meaning that no valuation tailwind is necessary to get great investment results with EVA Monsters. (These case studies explain this pretty well.)

As Charlie Munger said:

“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns 6 percent on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6 percent return – even if you originally buy it at a huge discount. Conversely, if a business earns 18 percent on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”

We also shared the math proof of why buying EVA Monster stocks at a fairish valuation makes perfect sense for long-term investors. (Look for the “math example” in this post to alleviate your doubts.)

To round off the short introduction, we (1) try to avoid overpaying for EVA Monsters, (2) closely monitor the fundamental performance and management’s capital allocation decisions throughout our holding period, and (3) hold our positions as long as the underlying investment thesis remains intact, ideally for decades, to let compounding do the heavy lifting.

Without further ado, numbers prove that Costco (COST) is a genuine EVA Monster and the king of physical retail, so it is worthy of your close attention. It is truly remarkable how this company has managed to carve out an undisputed wide moat in an extremely competitive landscape.

Costco operates an international chain of over 800 membership-only warehouses that carry quality, brand-name merchandise at substantially lower prices than are typically found at conventional wholesale or retail sources. Members can also shop for private label Kirkland Signature products, designed to be of equal or better quality than national brands, including juice, cookies, coffee, housewares, luggage, clothing, and detergent. The company also operates self-service gasoline stations and an e-commerce business unit. Costco was founded in 1983 and is based in Issaquah, Washington.

Costco’s culture of customer obsessiveness has deep roots that trace back to how the company’s legendary founder, Jim Sinegal, thought about building a business that would outlast all of us. He served as CEO from 1983 until his retirement in 2011, and he was well-known among workers for traveling to each location every year to inspect them personally. He also stated numerous times that the well-being of his employees was far more important to him than pleasing the insatiable need of Wall Street analysts for short-term profit maximization.

The firm derives the vast majority of its top line (98% as of fiscal 2022) from merchandise sales. Importantly, Costco’s products can only be purchased by members. Even though membership fees represent only a small fraction of the top line (2%), substantially all these revenues flow through to the bottom line, accounting for the lion’s share of Costco’s profits.

There are over 65 million paid members worldwide, with the annual fee for the Gold Star Membership currently at $60 in the U.S. Paid cardholders are eligible to upgrade to an Executive Membership (for an additional annual fee of $60) for Rewards and benefits. Notably, Executive members generated 71% of worldwide net sales in 2022. The company mainly caters to individual shoppers, but nearly 20% of paid members are businesses.

Costco is widely regarded as the originator of the “scale economies shared” business model, utilizing its operating leverage to pass on the resulting savings to customers. In turn, this results in an extremely loyal customer base, with retention rates consistently above 90% in its membership programs. Costco’s secret sauce lies in its obsessive focus on efficiency, which enables it to charge low-teens markups compared to 25-35% for a typical retailer.

Costco’s stores are large warehouses located in low-cost industrial areas. The company sells goods in bulk packaging, which eliminates the need for extra handling and shelf stocking, and substantially reduces theft occurrences. Crucially, Costco holds a limited number of stock-keeping units (SKUs), averaging 4,000 vs. up to 40,000 for a traditional supermarket. As a result, the firm’s U.S. sales per SKU were over $40 million, 10+ times higher than Walmart’s and Target’s metrics, contributing to its negotiation leverage in procurement.

Notably, we view Costco’s private label brand as a significant moat contributor. The major aim of Kirkland is to manufacture equal or better quality products than national brands at meaningfully lower prices, thereby fostering customer loyalty. Based on various industry reports, Kirkland contributes 25-30% to companywide sales at higher margins than branded SKUs. Standalone, Kirkland would be the largest consumer packaged goods brand in the U.S.

All things considered, we believe that thanks to its unique business model and relentless culture of efficiency, Costco has carved out a wide and enduring moat in the cutthroat retail space. This results in thin, albeit consistently positive and durable EVA Margins, and importantly, ROC levels that are completely unheard of in the physical retail industry.

Source: ISS EVA, The FALCON Method

As for the future, Costco typically opens 20-30 new warehouses each year, and it has historically grown its same-store sales at a mid-single-digit rate annually. These equate to a continued high-single-digit growth potential in product sales. The growth characteristics are largely similar in the membership aspect of the business as well, so Costco should be able to grow its top line by 6-8% annually over the long run. Our models also show that Costco’s EVA growth potential could outpace its sales trajectory and reach double-digit territory for years to come.

As for capital allocation, Costco operates with a relatively low reinvestment rate, primarily aimed at new store development and enhancing its Kirkland brand. Meanwhile, ROC levels are on an upward trend as rising same-store sales are driving improved capital efficiency.

Turning to capital distributions, the company first initiated a dividend in 2004 and has been increasing it ever since at a healthy double-digit rate. The ordinary dividend uses only about 25% of internally generated cash, translating to unquestionable safety. The firm also has a history of paying special dividends to its owners. Costco also carries out share repurchases; however, restricted stock units provided to employees (generous enough to make it one of the best retailers to work for) largely negate the effect, leading to a historically stagnant share count.

Looking at the stock’s valuation, we would have eagerly acquired shares during the financial crisis when the FGR metric fell close to 0%. However, aside from a surge in EVA thanks to COVID-induced stockpiling in 2020-2021, the company’s multiples have generally remained stretched. Please see below the valuation metrics of the EVA framework that remedy accounting distortions to give us a clearer picture on where the stock stands in a historical context.

(Curious why we don’t use the most popular multiples? Find out here!)

Regardless of how we look at it, the current valuation sits at the very high end of Costco’s historical range. Waiting for the valuation component to become at least neutral to the total return formula seems a reasonable approach at this point.

Overall, the time to get excited is not now. The “Key Data” table and the 5-year total return potential chart speak for themselves.

Source: ISS EVA, The FALCON Method

The FALCON Method can identify much better opportunities in the current market, so we are passing up on Costco for now.

The verdict

What first comes to mind when assessing risks surrounding this business model is that, over time, consumers might increasingly turn to digital channels to fulfill their shopping needs. If Costco were unable to successfully develop a relevant omnichannel experience (which may also come with elevated investments, hurting profitability), its operations could be adversely affected.

It’s a tough call at this point, but Amazon’s extensive network of warehouses and fulfillment centers could serve as a foundation upon which it might try to replicate Costco’s business model, leveraging its preexisting Prime membership base.

While challenges like the rise of e-commerce or Amazon’s push into grocery do pose threats, we would be more than happy to own this business at the right price. With an operating model that has thrived for over 50 years, an exceptional leadership team focused on long-term value creation, and significant opportunities for overseas expansion, we think the company has a bright future. As for position sizing, we would be comfortable with a 3-5% exposure.

The company ranked 40th of our 60 EVA Monsters at the time of writing, based on its 5-year total return potential. (Businesses from 12 countries are represented on our EVA Monster list.)

It is safe to say that there are far more attractive EVA Monster stocks to buy in the current market, with the highest-ranking ten boasting total return potentials above 12% over our modeled 5-year timeframe. (You can always find the monthly Top 10 in the FALCON Method newsletter along with our entry price recommendations.)

Want to learn more about our ranking methodology? Start with this blog post!

Slaying the Sacred Cow of the Efficient Market Theory

Throughout the years, I kept emphasizing in the FALCON Method Newsletter that the current market price of a stock might have nothing to do with the value of the underlying business. While this statement is the cornerstone of value investing, it may sound disturbing for those familiar with the names and theories of reputable economists contradicting me. (Burton Malkiel, Eugene Fama, and Paul Samuelson come to mind, the latter two of them being Nobel Laureates.) There’s no way to invest successfully without seeing clearly who is right—the academics or the real investors—so it is vitally important that you understand the points I outline below.

To lay the groundwork, let me quote Warren Buffett’s letter from 1988 first. “[The efficient market theory] doctrine became highly fashionable – indeed, almost holy scripture in academic circles during the 1970s. Essentially, it said that analyzing stocks was useless because all public information about them was appropriately reflected in their prices. In other words, the market always knew everything.” According to the EMT, price equals value, and that’s it.

Now let me show you two real-life examples that may make you think twice about what this theory says. On January 4, 2000, Yahoo! stock was selling for $500 per share. The business had a market cap of $505 billion at the time. The earnings were $47 million, and the PE ratio was 11,478! As value investor Phil Town writes, “Assuming the earnings were growing at some astronomical rate, say 36 percent a year, how long before we’d get our money back? Sixteen years. Never mind that no company ever grew that fast for that long starting that big. […] Oh, and if it did somehow grow that fast, the earnings would be over $300 billion. Exxon just had record earnings in 2008 of $45 billion. Earnings of all of the U.S. stocks traded regularly that year added up to about $300 billion, so Yahoo! all by itself would have to become pretty much the whole stock market to make sense out of that price. Yes, Professor, stocks do get mispriced from time to time. Just a bit.”

Scott McNeely was the CEO of Sun Microsystems, one of the darlings of the tech bubble. At its peak, his stock hit a valuation of ten times revenues. A couple of years afterward, he had this to say about that time: “At ten times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for ten straight years in dividends. […] That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next ten years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

As a side note, you don’t have to look further than the tech sector to find companies trading at 10 to 15 times revenues today. I don’t know if they will follow the same path Sun did, but it certainly looks like there are tons of investors who will, at some point in the future, be asking themselves once again, “what were you thinking?”

I hope these two examples managed to highlight that the stock price and the value of the underlying business can diverge from time to time. The hypothesis of a totally efficient stock market simply doesn’t stand. After all, if you spot one single black swan, you have to abolish your hypothesis that all swans are white. And these examples show glaring market inefficiencies! On the other hand, the efficient market theory (EMT) is not 100% wrong either. The truth is somewhere in between, as Warren Buffett writes:

“Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day.”

In fact, Professor Malkiel, a pioneer of EMT, came to similar conclusions when he was asked after the 2000 to 2003 stock market debacle how some very good businesses could see their stock prices drop by 90 percent if the market was truly efficient. Very interestingly, he came as close to junking his theory as an academician ever could when saying, “In the long term, I think that [markets] are generally efficient. Though I’ll admit, they do go crazy from time to time.” So, Professor, the stock market is efficient, but sometimes it’s not. Sounds funny, but this is exactly what Buffett and other value investors have been saying for the past 50 years. And that “sometimes it’s not” part is what creates windows of opportunity for thoughtful investors. (By the way, did you know that Nobel-winning proponent of EMT, Paul Samuelson himself, invested in Berkshire Hathaway stock?)

Honestly, which camp looks stronger at this point: academics or real investors? For my part, I’d let economists keep their Nobel prizes while I’m becoming a rich statistical anomaly according to their models. That’s fun, believe me! After all, if you accept that the market price of stocks and the values of underlying businesses can diverge from time to time, all you need is the patience of a hunter to do nothing when companies are overpriced and to strike aggressively and buy when companies are priced far below their value. Did you know that a giant crocodile can go without eating for 12 months, waiting for the right opportunity to pounce on its prey? When learning this at Dubai Mall’s Aquarium, I already thought this was the exact kind of virtue true investors need to possess. We only strike when something appetizing comes along; in the meantime, we wait.

For value investors, cash size is usually a result of not being able to find anything to buy, and that’s the right approach. Rather than going to cash as a strategy and trying to time the market, it comes naturally for value investors as we do not like to overpay.

One thing to keep in mind, though, is that your standard reaction to a steep decline in the price of your stocks involves typical efficient market theory thinking. “Why is the price going down? There must be a serious problem that I don’t understand. Time to cut my losses and run away.” Whenever such garbage crosses your mind, please remind yourself that the market price of a stock can and does deviate from the underlying value time and again. The hypothesis of a totally efficient stock market has been proven dead wrong, and even one of its Noble winning proponents was investing with Warren Buffett.

In summary, value investors have every reason to be grateful for how Mr. Market operates. Most of the time, this bipolar fellow is taking his meds, so on most days, he’s pretty lucid and rational about the prices he buys and sells at. That means most of the time, the price of a business is pretty close to its value. On some days, however, he gets overwhelmed by his mood swings and gives us opportunities to pounce on. If you only remember one sentence from this writing, make it this one: If markets weren’t short-term inefficient, we would make no money, and if markets were not efficient in the longer term, we would make no money. The long-term efficiency part of the equation is needed so that valuation multiples can revert to their mean, giving us a nice capital appreciation in addition to the dividends collected along the way. Now you know why the market is perfect just the way it is.

Want to learn more about our stock ranking methodology and evidence-based investment approach? Start with this blog post!

Or read more like this in the Beyond Dividends book.

The EVA Monster Series: The King of Supercar Manufacturers

With this series, we’d like to give you some perspective on the companies in our distinguished EVA Monster universe. This rare breed of quality-growth stocks is worthy of your attention, and getting to know these businesses may pay off handsomely down the road.

As a quick recap, EVA Monsters have three things in common:

  • They earn high returns on the capital they employ.
  • They have growth opportunities that allow them to reinvest most of their cash flows at high rates of return.
  • They have a sustainable competitive advantage (that Warren Buffett calls “moat”), which prevents their competitors from taking away their extraordinary profitability.

These characteristics tend to result in a strong (double-digit) fundamental return potential, meaning that no valuation tailwind is necessary to get great investment results with EVA Monsters. (These case studies explain this pretty well.)

As Charlie Munger said:

“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns 6 percent on capital over 40 years and you hold it for that 40 years, you’re not going to make much different than a 6 percent return – even if you originally buy it at a huge discount. Conversely, if a business earns 18 percent on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with one hell of a result.”

We also shared the math proof of why buying EVA Monster stocks at a fairish valuation makes perfect sense for long-term investors. (Look for the “math example” in this post to alleviate your doubts.)

To round off the short introduction, we (1) try to avoid overpaying for EVA Monsters, (2) closely monitor the fundamental performance and management’s capital allocation decisions throughout our holding period, and (3) hold our positions as long as the underlying investment thesis remains intact, ideally for decades, to let compounding do the heavy lifting.

Without further ado, numbers show that Ferrari N.V. (RACE), the king of supercar manufacturers, exhibits EVA Monster characteristics and is thus worthy of your attention. Make no mistake; this is not a lousy car maker but a true luxury company! The prancing horse stands for much more than just a vehicle: it’s a symbol of prestige and elite craftsmanship.

Ferrari engages in the design, engineering, and production of luxury performance sports cars. Its iconic vehicles range from standard models (such as the Ferrari Roma) to racetrack-suitable cars (like the Daytona), adhering to the motto “different Ferraris for different Ferraristi.” The firm also has a long tradition of participating in the Formula 1 series, with the prancing horse logo and the signature “Rosso Corsa” red color becoming synonymous with the Scuderia Ferrari racing team. The company was founded in 1947 and is headquartered in Maranello, Italy. Fiat Chrysler Automobiles spun off Ferrari in an initial public offering in 2015, listing its shares on both the NYSE and Euronext Milan.

The overwhelming majority of Ferrari’s top line (85% in fiscal 2022) comes from the sale of cars and spare parts. The firm markets its models through an exclusive dealer network, with the average realized sales price per vehicle consistently exceeding $300,000. Furthermore, personalization can significantly increase the final price, and certain limited production and one-off models (such as the iconic LaFerrari series) can easily sell for over $1 million.

As noted above, Ferrari stands apart from conventional automakers, aligning more closely with luxury fashion houses such as Hermès or Chanel. Accordingly, the company also prides itself in its rich heritage, dating back almost a century when its founder, Enzo Ferrari, formed the Scuderia Ferrari racing team in 1929. Since then, Ferraris have been known for their superior driving experience, drawing on cutting-edge technology from the firm’s Formula 1 racing arm, which also spurs demand for their road cars.

True to its founder’s belief that “the engine is the soul of the car,” Ferrari continues to design, develop and handcraft its powertrains in Maranello, along with other core components critical in differentiating the technology and performance of its cars. The “Made in Italy” badge resonates similarly to that of prestigious luxury fashion houses, where the outsourcing of production would be unimaginable.

Interestingly, Ferraris retain their value significantly better than any other brand in the luxury car market, reducing the total cost of ownership and providing a form of investment for the most affluent customers. Ferraris make up 10 of the top 20 most expensive cars ever sold at auctions. Client loyalty is also remarkable, with two-thirds of new cars sold to existing owners, of which every second customer already has more than one Ferrari.

A central aspect of Ferrari’s exclusivity is the limited number of models and cars they produce, often leading to wait times of up to two years and no discounts, despite the lofty price tags. The brand produces just over 13,000 vehicles per annum, significantly lower than, for example, Porsche’s 300,000+ figure. As Enzo Ferrari famously noted, “Ferrari will always deliver one car less than the market demand.” A beneficial outcome is that with an order book full for up to two years in advance, unit volatility and hence revenue cyclicality is lower compared to peers (let alone high-volume automakers).

In our view, Ferrari deserves the wide-moat badge from a qualitative standpoint, with a competitive advantage period likely to last for many decades to come. Judging from the quantitative angle, Ferrari consistently delivers double-digit EVA margins. The firm significantly exceeds typical car manufacturers with these figures, which can barely generate positive economic earnings over full cycles.

Source: ISS EVA, The FALCON Method

As for the future, the firm’s total addressable market keeps expanding at a healthy pace, and repeat customers are also showing incredible loyalty, so healthy sales growth is almost guaranteed.

On the one hand, since the majority of production vehicles land at existing owners, it’s quite clear that volume growth could continue to rise at least in line with the expansion of the HNWI customer group, all while maintaining the brand’s aura of exclusivity. On the other hand, the company’s sales growth has consistently and significantly outpaced its volume trajectory, demonstrating strong pricing power. Overall, we estimate Ferrari’s long-term sustainable sales growth rate to be in the high-single-digit territory.

Switching gears to capital allocation, Ferrari’s reinvestment rate sits between 40-50%, paired with ROC levels nearing 20%: metrics completely unheard of in the auto industry. The main areas of capital expenditures are R&D investments and production capacity expansions. Concerning capital distributions, Ferrari has paid a dividend since its IPO, although the payout fluctuated with the company’s annual earnings.

While it would be misguided to value this company like an average automaker, even the most pessimistic historical snapshots imply a more than 15-year explicit EVA growth period at a healthy CAGR, which feels very optimistic to our taste. Please see below the valuation metrics of the EVA framework that remedy accounting distortions to give us a clearer picture on where the stock stands in a historical context.

(Curious why we don’t use the most popular multiples? Find out here!)

That being said, Ferrari’s unprecedented quality would pique our interest in this stock at the lower end of its historical valuation range. In our model, the valuation component acts as a meaningful headwind to the otherwise excellent fundamental return potential, as shown below.

Source: The FALCON Method

Overall, the time to get excited is not now. The “Key Data” table and the 5-year total return potential chart speak for themselves.

Source: ISS EVA, The FALCON Method

The FALCON Method can identify much better opportunities in the current market, so we are passing up on Ferrari for now.

The verdict

The most pronounced risk with any luxury company is that short-termism can kill long-standing intangible assets. In this specific case, management could let go of volume restriction to increase sales or cut R&D expenses to boost the bottom line. In essence, leadership could damage or outright destroy Ferrari’s crown jewel of assets, its brand value, by putting too many cars on the road.

Speaking of F1, Ferrari’s results in the past couple of years were most likely below the company’s expectations. Should the team fail to reclaim its historical position as the premier racing garage in the league, its brand image and hence sales of road-going Ferraris may also be affected.

The auto industry’s push toward fully electric vehicles could also pose a serious challenge, as do self-driving cars. (Just think about how the absence of charismatic, roaring V8 or V12 engines could hurt user experience and render the electric drivetrain more commodity-like.)

All in all, Ferrari’s unprecedented quality would pique our interest in this stock at the lower end of its historical valuation range. As for position sizing, we would be comfortable with a 3-5% exposure, geared toward the higher end at the proper price.

The company ranked 44th of our 60 EVA Monsters at the time of writing, based on its 5-year total return potential. (Businesses from 12 countries are represented on our EVA Monster list.)

It is safe to say that there are far more attractive EVA Monster stocks to buy in the current market, with the highest-ranking ten boasting total return potentials above 12% over our modeled 5-year timeframe. (You can always find the monthly Top 10 in the FALCON Method newsletter along with our entry price recommendations.)

Want to learn more about our ranking methodology? Start with this blog post!

Top Stock Investors: What Separates the Best from the Rest?

Confessions first: Have you ever decided on a stock purchase (or any other investment) based on a write-up, blog post, or third-party analysis?

I’m guilty as charged, so don’t feel bad about this.

It’s a widely held fallacy that following what renowned investors (like Buffett) or well-paid Wall Street analysts do and say is more than enough for investment success.

Sorry to spoil the “Yes, Virginia, there is a Santa Claus” moment, but let me be the bearer of bad news. That’s not how outstanding investors work, and they have their reasons!

Don’t get me wrong; while monitoring the 13F filings of “superinvestors” may be useful, mindless coat-tailing won’t get you anywhere. As the saying goes, “You can borrow someone’s ideas but not their conviction.”

Borrowing an idea is seldom enough to take you to the finish line. You will need conviction about the stocks you invest in; otherwise, you won’t be able to hold them through thick and thin.

Other investors’ ideas should only act as inputs to be fed into your independent investment process. Yes, you do need a process you trust! If it’s evidence-based, like the FALCON Method, even better.

“If you can’t describe what you are doing as a process, you don’t know what you’re doing.” (W. Edwards Deming)

Cracking open The Wall Street Journal and buying the first stock mentioned is not a sound process, yet many speculators are operating at such a level (for their brief spell in the markets). For those in it for the long run, like me, no 2-second solution will cut it.

For my part, I had a well-established dividend growth investment process that made me financially free by 33. Subsequently, I managed to upgrade my stock-picking method to a whole new level, and it was a heck of a journey! You can follow my evolution in the Beyond Dividends book. (Where else can you get decades of investment experience for the price of a book?)

I’m a little embarrassed to admit, but at 41, nearly all my life was about making money. The only benefit I can highlight as a result (besides the obvious financial part) is that sharing all my discoveries can help others like you to switch to the fast lane and spare years of experimenting and agony.

Let Beyond Dividends make you think, question your long-held beliefs, and help you discover what investing style and strategy may fit your personality. After all, it’s your conviction that gets you through the night, so that’s the single most important factor of investment success.

In closing, let me share something deeply personal with you. My first book has sold more than 12K copies (and it’s not even translated into English). Over the years, the feedback I received often brought tears to my eyes, while the royalties I made could comfortably qualify as crumbs. Publishing a book is far from a great business. (Any author will tell you this, except for the luckiest 1%.)

Whenever someone with decades of investment experience devotes their time and energy to such a project, I’m always among the first buyers of their books, knowing I’ll vastly underpay for the gift they give the world by sharing all their ideas and experience. This attitude contributed greatly to my achievements, and if it resonates with you, feel free to follow suit.

By taking action now and reading Beyond Dividends, you empower yourself to take control of your financial life. Stop being the chess piece; become the player… and a master at that! Beyond Dividends is your next right move; order it here and now!

Misleading Simplicity: The Hidden Pitfalls of Valuing Stocks

Bad news first: your brain is not hardwired to make you a successful investor.

Throughout evolution, survival was our number-one aim. Long books on cognitive biases are filled with how ill-equipped we are when it comes to navigating financial decisions.

To today’s point: we all are heuristic thinkers, meaning we use mental shortcuts to simplify problems and avoid cognitive overload. Like, “That stock is cheap; it’s trading at a 7 P/E.”

Sounds familiar?

For the record, before we move on: No stock is cheap because it trades at a low multiple, and no stock is expensive because of its high P/E. They both may be worthy of the valuation Mr. Market assigns to them. More on this in my Beyond Dividends book.

How hard do you think it is to access the most popular indicators and multiples like the P/E ratio? Indeed, all are just a mouse click away, completely free. So why isn’t everyone super successful in the stock market?

Because heuristics may have kept our ancestors alive on the savannah, but they don’t work in investing! There must be more to investment success than a handful of widely used (and terribly flawed) metrics that are easy to access, even for a fifth-grader.

By the way, what’s easy will always become overly popular and will thus stop working. As William Bernstein wrote in his book Skating Where the Puck Was, “the first people to invest in an asset class with high expected returns and low correlations enjoy sirloin, while the Johnny-come-latelys get hamburger.” Whenever an asset seemed to offer portfolio theory’s version of the Immaculate Conception: high returns combined with low correlations with other standard portfolio components, it always got discovered, became easier to buy and own, and thus its initial advantage disappeared.

What’s easy and profitable will never last. That’s what financial history teaches us.

Now that you know what doesn’t work, let’s see what does! A gentle warning, which you may expect after the intro: the solution is not of the 2-second click-for-riches kind.

Reading and learning as much as possible about the companies trading on the stock exchange is the basis of everything we do at the FALCON Method. (See the fifth step of our process in this post.) We aim to understand whether a firm has a sustainable competitive advantage that may enable it to earn spectacular returns for its shareholders. Identifying the moat characteristics and understanding the moat’s primary and secondary drivers is absolutely essential to make sound long-term investment decisions. And yes, it takes time and effort—lots of it.

Once we have a picture of a business’s competitive position, prospects, and the most important drivers to watch, we are ready to put together its financial model based on distortion-free metrics (Economic Value Added, aka EVA). This modeling, scenario building, and premortem-like identification of the probability tree’s hidden branches take us to our well-founded estimate of the annualized total return potential the firm’s shares may offer investors at the current price.

Yes, our process involves several moving parts. Nevertheless, by getting to this point, we have discovered and understood pretty well what factors and value drivers are crucial for the company we analyze, and this knowledge sets us apart from the crowd.

If this sounds shockingly complicated, let me assure you that I didn’t start out at this level of knowledge and understanding. I had to learn everything on my own, sometimes the hard and expensive way.

Luckily, you can follow in my footsteps, sparing a lot of time as my Beyond Dividends book reveals my journey in detail, with all the key takeaways that can make you a better investor. I’m willing to wager you’ll never again decide on a stock based on its P/E, and that’s just the beginning.

Seriously, decades of learning and experience are condensed in this easy-to-read, entertaining, albeit thought-provoking book, so grabbing your electronic copy qualifies as a no-brainer investment in your education.

From Good to Great: How to Upgrade Your Investing Strategy

“Playing the stock market is easy.”

I kept bumping into such boastful statements until Barstool Sports founder, Dave Portnoy, took this foolishness to the highest possible level by saying he was a better investor than Warren Buffett and that day trading was “the easiest game.”

Look, no one is supposed to “play the market.” Stock investing is a profession, period.

The stats undeniably show that the overwhelming majority of traders and investors fail. Based on brokers’ available data, 87% of all retail traders lost money trading forex in 2022. Stock investors/traders fare somewhat better: 80% lose, 10% break even, and 10% make money consistently.

Being in the last 10% of consistent money-makers, I know what separates me from the rest of the pack. I already had more than 10,000 hours of investment-related reading and thinking under my belt by the time I turned 35. Not to mention the firsthand experience of costly and painful lessons (along with success stories). As per Malcolm Gladwell’s principle, popularized in his Outliers: The Story of Success book, I easily qualified as a stock investing expert, although I’d never label myself as such. (A healthy dose of humbleness comes in handy if you are to survive and thrive in the markets.)

I share this because I seemingly had all the reasons to feel satisfied and retire as soon as I achieved financial freedom with my proven investment approach. And that’s what I did! Resting on my laurels and celebrating my achievement felt right… for about two weeks.

I knew all too well that entropy would kick in. If something’s not growing, it is slowly dying. If you’re not learning and getting better, only the painful downward slope remains. Fortunately, one of my friends convinced me to start teaching “this financial independence investing thing.” Being bored in my (way too early) retirement, jumping into this worthwhile project felt energizing.

I completed all of Columbia Business School’s Value Investing courses (the place is considered the cradle of value investing) and read hundreds of books… so why not pass on my knowledge for others to use and benefit from? After writing a best-seller on dividend investing and publishing top-selling online courses, the real milestone was launching the FALCON Method newsletter.

Looking back, I most certainly didn’t foresee how operating a newsletter service with 1,000+ subscribers (from 33 countries at last count) could impact my learning curve over the years. The incoming questions and feedback made me delve deeper, pushing me to explain complicated concepts in a digestible, easy-to-understand manner. Both my investing style and writing skills markedly evolved throughout this journey.

My mantra is, “There’s always something to learn.” I was reading the not-so-enjoyable-but-useful Best-Practice EVA book while finishing up my preparations for Ironman Barcelona (a long-distance triathlon race). Right there, before the event, I got in touch with the author’s team and asked tons of questions. Long story short, I managed to gain access to an institutional-level data service that helped remedy accounting distortions, thus paving the way for my further evolution.

The reason for sharing this is to emphasize that learning never stops; it is never supposed to stop. Warren Buffett’s business partner, Charlie Munger, summed it up perfectly:

“Develop into a lifelong self-learner through voracious reading; cultivate curiosity and strive to become a little wiser every day.”

I know absolutely no successful people who do not read a lot. My story and evolution as an investor are shared in the Beyond Dividends book, which is a compilation of the FALCON Method newsletter’s writings.

You can learn how I transformed from a pure dividend investor into a more versatile stock picker who understands when real value resides in growth but can differentiate between harmful and value-creating growth. (Hint: financial statements are not too helpful in and of themselves.)

Beyond Dividends may open new horizons for even those who think they already know everything. (I fell into this trap before reaching a whole new level, remember?) I bet that Beyond Dividends will make you contemplate and maybe even question some of your long-held beliefs. That’s exactly what makes a book useful, and that’s why I keep devouring them long after passing the financial freedom milestone. How about you?

The Biggest Limiting Belief Holding You Back from Successful Investing

If you’re like me, reading your first investment book must have made you super excited.

“I can do this! It sounds totally reasonable. And getting rich is a nice byproduct.” Thoughts like these arose as I was eager to grab the next book.

Fast forward, and I’m sure you’ll agree that after reading the first 5-10 investment books, the messages start to become repetitive or controversial.

Either way, it only takes a few months for the typical person to convince themselves that they know enough to strike it rich in the stock market.

Too bad those books lie to you. They overpromise and underdeliver.

Most serious investors have read many of the investing classics, yet the data indicates they still don’t materially outperform. (At least they don’t even come close to the level of outperformance of people like Warren Buffett and Peter Lynch.) Have you ever thought about this?

The reasons may be twofold: (1) investing is a profession, so while reading is a good start and essential, it alone won’t make you successful, and (2) there’s no incentive for Buffett or any other professional to educate the masses on how to compete with them.

Let me add a third, thought-provoking point: the stock market keeps evolving (changing), as it is a complex adaptive system built on many investors’ personal views and transactions (and their behavioral biases). There’s always money to be made in the market, but winning strategies do not stay constant! You need to keep learning and adapting.

The biggest investors are the best examples of this! After all, Warren Buffett’s current investment approach has absolutely nothing to do with his initial strategy. The hardwired value investor Howard Marks has just recently made the leap to recognize the value residing in profitable growth. And last but not least, a telling example from Morgan Housel:

“The Intelligent Investor is one of the greatest investing books of all time. But I don’t know a single investor who has done well implementing Graham’s published formulas. In each revised edition, Graham discarded the formulas he presented in the previous edition and replaced them with new ones, declaring, in a sense, that ‘those do not work anymore, or they do not work as well as they used to; these are the formulas that seem to work better now.’ Graham died in 1976. If the formulas he advocated were discarded and updated five times between 1934 and 1972, how relevant do you think they are in 2020? Or will be in 2050?”

On a positive note, while ancient formulas may not work today, and no strategy produces outstanding returns forever, there IS an attitude that has more than stood the test of time! That’s the love of reading, learning, and discovering.

For my part, I keep devouring 50-70 books per year, and half are still investment related (almost a decade after reaching financial freedom). It may be embarrassing to admit, but nearly all of what I read pertained to investments when I was starting out.

After hundreds of titles, I certainly know a thing or two about them being repetitive and controversial. That said, whenever an experienced investor releases a new book, I regard it as a gift, a wonderful gesture. After all, no such publication can be priced too high compared to the experience and lessons delivered.

All books are underpriced. This is the most underpriced “asset class” in the world. That’s been my opinion since I turned 20, and nowadays, I see this echoed by renowned investors and business people.

When was the last time you read a book that had a lasting impact on you? Your values, identity, and life are shaped by the books you read and the people you meet. While meeting in person and learning from the best is out of reach for most, your ability to read and your love for it can be a true blessing.

Ending on a semi-selfish note, if you’re looking for the book with the power to question your long-held beliefs and take you to the next level as an investor, look no further than Beyond Dividends (authored by yours truly).

This compilation encompasses my evolution from a hardwired dividend investor to a more versatile quality-growth mindset with a strong income focus. If you’re tired of theoretical academic lessons and prefer practical advice and conclusions from decades of investment experience, all this delivered in an entertaining, easy-to-digest manner, you should give my latest book a shot.

This recommendation is semi-selfish in the sense that you’ll benefit much more from reading than I will from your purchase. Don’t withhold your feedback!

Embrace the Negativity that Surrounds Your Stocks

I usually read 4–5 books per month, and although not all of them are investment-related, I often find striking parallels between the actual topic and the way I invest. The title “Scorecasting: The Hidden Influences Behind How Sports Are Played and Games Are Won” serves as an excellent example.

Following conventional wisdom leads to suboptimal choices most of the time, both in the field of sports and investing. David Romer, a prominent Berkeley economist, says that the play-calling of NFL teams shows “systematic and clear-cut” departures from the decisions that would maximize their chances of winning.

Based on data from more than 700 NFL games, Romer identified 1,068 fourth-down situations in which, statistically speaking, the right call would have been to go for it. The NFL teams punted 959 times. In other words, nearly 90 percent of the time, NFL coaches made the suboptimal choice. Of course, that suboptimal choice was the conventional one. After all, as a manager, it is harder to lose your job by making a typical decision than by doing something unusual, even if the latter had a higher expected value.

Scorecasting highlights several examples like the above. “We found that NHL teams pull their goalies too late (on average, with only 1:08 left in the game when down by one goal and with 1:30 left when down by two goals). By our calculations, pulling the goalie one minute or even two minutes earlier would increase the chances of tying the game from 11.6 percent to 17.6 percent. Over the course of a season, that would mean almost an extra win per year. Why do teams wait so long to pull the goalie? Coaches are so averse to the potential loss of an empty-net goal—and the ridicule and potential job loss that accompany it—that they wait until the last possible moment, which actually reduces their chances of winning.”

What does this have to do with investing? Well, the evidence cited above has just killed the notion of full rationality (had you ever signed up for the rational person hypothesis in the first place). If you lose the ordinary way—by doing what you are expected to do—everyone will gladly commiserate with you, and you can simply blame that loss on bad luck. Imagine, in contrast, what would happen if you dared to do something extraordinary that didn’t turn out so well. Lose in a “stupid way,” and you are left alone to draw conclusions and get back to the herd as soon as you are ready to follow the conventional wisdom again.

Of course, this is just hindsight bias. If you did the right thing but failed because of bad luck, you’re labeled stupid. If you did the wrong thing but succeeded because of good fortune, you’re hailed as a genius. In reality, it’s often the opposite, but the psychological burden of going against the crowd is enormous.

Are you familiar with the process-outcome matrix? Focus on the process you can control, and don’t let the short-term outcome divert you from the winning strategy! This message is so important to keep in mind that I have the matrix on my fridge door.

As long as you are buying the overhyped and overvalued darlings of the market, you are doing everything right from the herd’s point of view. Underlying probabilities say that your performance will not be that great, but hey, you’ll have a lot of people to commiserate with! What if you bought an out-of-favor stock instead? As investing is probabilistic and never deterministic—although the base rate may support you—there is absolutely no guarantee that your particular pick would perform well. If, for some reason, it turns out to be a subpar investment, you will get the rotten tomatoes for purchasing the stock of a company that was “so apparently a dud.”

Can you handle the pressure of going against the crowd and being wrong sometimes? This brings us to the next psychological issue of the not-so-rational person, the question of broad vs. narrow framing. Narrow framing means that every stock matters to you individually, and you want to win with all of them. Coupled with the standard loss aversion, this narrow framing leads to disastrous performance and a lot of misery. Closely following daily fluctuations is a losing proposition because the pain of frequent small losses exceeds the pleasure of equally frequent small gains.

In contrast, broad framing means that you want your stock portfolio as a whole to perform well, and you are not that focused on individual stock positions within that portfolio. This latter frame of mind can hugely increase the willingness to invest in stocks (the proven best asset class for wealth building). For my part, I would never take one single bet even with the odds in my favor, but I gladly take that same bet if I am allowed to do it many times so that probabilities can play out and my advantage can materialize. Call me risk-averse, but this is exactly what broad framing is about!

It is easier said than done, I know. Scorecasting highlights that professional golfers are also risk-averse and plagued by narrow framing. In golf, the idea is to maneuver the ball into the hole in as few strokes as possible on every hole, no matter what. Even Tiger Woods—so unflappable, so mentally impregnable—changes his behavior based on the situation and putts appreciably better for par than he does for a birdie, evaluating decisions in the short term rather than in the aggregate. He should optimize for the total number of strokes, yet he is deviating from that strategy. Analogize this to your retirement portfolio. You simply want the most favorable total at the end. It shouldn’t matter how you got there. The soundness of the underlying process is decisive. However, a single year’s or position’s performance is of minor importance in the grand scheme of things and should thus never be taken too seriously.

As we are aiming for above-average returns, the FALCON Method goes against the crowd most of the time. However, simply being contrarian—doing the opposite of what others are doing—would be just as foolish as following the herd; this is why we pick our spots carefully and employ an evidence-based investment method that is “selective contrarian” in style. Some subscribers emailed me their concerns that they had read negative articles and analyses about the companies in our FALCON Portfolio. As long as the factually proven underlying factors of our stock selection process are pointing toward a buy decision, you should be happy to bump into all those negative articles since they create and keep up the sentiment that diverts the stock’s price from its intrinsic value. By the time positive articles start to surface, your portfolio will be loaded with quality stuff purchased at bargain basement prices. E.g., I bought McDonald’s at $92.59 when positive opinions and analyst recommendations were nearly impossible to come by. The same with Microsoft at $41.05. I encourage you to take a look at the current prices of these two stocks and the positivity of the most recent articles and analyses on them. By the time the cheerleaders appear on stage, you should be done with your buying.

As an individual investor, you can have the enormous advantage of long-term focus. Unlike the NFL manager (not daring to go for it on fourth-down) or the wealth manager on Wall Street (sticking to the current darlings of the market), you will not be fired if you make unconventional evidence-based choices instead of the typical, often suboptimal ones.

Want to learn more about our stock ranking methodology and evidence-based investment approach? Start with this blog post!

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