Market Matters for January 18, 2013
Below is a weekly update from our Chief Investment Officer, Dr. Scott Lummer. He co-hosts a seven minute audio segment entitled “Market Matters.” In this week's show, Scott discusses the returns of Apple stock. He explains why there are greater risks in buying individual stocks, and how investors can avoid those risks through diversification. Each week he covers a different piece of investment news focusing on recent events in the capital markets, and relates them to Savant Investment Group’s perspective on investing.
Daphne: My name is Daphne O’Neal, and welcome to Market Matters. This week, we are going to talk about buying individual stocks. As always, we will talk about this with the Chief Investment Officer for the Savant Investment Group, Dr. Scott Lummer. Dr. Lummer, I was reading that investors in Apple are very disappointed in the stock’s performance.
Scott: Since mid September, the price of Apple has fallen by 30%, so investors have good reason to be disappointed.
Daphne: Why is that? The overall stock market hasn’t fallen, has it?
Scott: Actually, over the same time, the S&P 500 has risen by a couple of percent.
Daphne: So it must be something about Apple itself. I would think that such a decline would mean the company was in trouble, but I think Apple is very healthy.
Scott: It is healthy – in fact, it’s probably never been healthier. The issue is expectations. Throughout most of 2012, there were building expectations for new product sales, particularly for the iPhone 5. Over the first 8 ½ months of 2012, the stock increased by 70% because of those expectations.
Daphne: Hasn’t the iPhone sold well?
Scott: The term “well” is a relative. There are a lot of iPhones and iPads being sold, but probably not as many as most investors were expecting.
Daphne: You have said several times that 2012 was a relatively calm stock market. It doesn’t seem like it was too calm for investors in Apple?
Scott: That’s a great point, Daphne. The purchase of individual stocks is always very risky proposition. It seems like it is easy – buying well known companies that are performing well – but it’s more complicated than that.
Daphne: How is investing in a stock like Apple different than investments that you have discussed before, like investing in mutual funds?
Scott: The main difference is diversification. When you invest in an individual stock, you have the types of risks we have just described. Individual company earnings, disappointing sales, strikes, etc. Plus you have all of the broader economic risks as well, because they affect individual stock prices too. By not diversifying, you are taking on much more risk than if you diversify across many stocks.
Daphne: Last week when you were talking about emerging markets, you pointed out their risk, but said in order to get that extra return, you have to take on the additional risk. What doesn’t
that apply with individual stocks?
Scott: While it’s true over the long term the only way to get additional return is to take on additional risk, the reverse is not necessarily true. You do not get additional return simply by taking on additional risk. If you go to a casino and take on big risks by playing roulette, that does not get you high expected returns.
Daphne: Can’t investors diversify on their own and buy their own stocks?
Scott: Certainly they can. But there are three issues with that. First, it can be expensive. To diversify a stock portfolio properly you need at least 20-30 stocks. That means relatively small purchases, which will mean relatively large trading commissions. Second, there is a lot of science that professional investors use in building a portfolio to ensure proper diversification. It involves careful selection of various industries, differently sized companies at different valuation levels, and choosing the proper weighting for the stocks.
Daphne: Can’t that science be learned?
Scott: Of course it can – but that takes a lot of time and effort.
Daphne: You said there was a third issue.
Scott: Third and probably most important is the informational and intuitive skill it takes to pick out the stock purchases. The buying of individual stocks is a risky and highly competitive business. You would be entering a competition in which there are literally millions of other smart people participating. And many of those competitors are true professionals, with years of education, training, and experience, and teams of colleagues spending all of their working time analyzing stocks with sophisticated quantitative models at their disposal.
Daphne: How would that have made a difference with Apple?
Scott: If you’re considering buying Apple, you know a lot of things about the company. But the investors you are competing with – they have looked at industry marketing reports, they have talked directly to the CEO and other employees, they have visited the office and manufacturing and engineering facilities, they have talked to competitors, suppliers, and engineers. Remember that if you are buying a stock, someone else is selling it, and thousands of others are considering buying it, but have chosen not to do so at that high of a price. So you have to ask yourself, why are you smarter than everyone else in the competition? It’s the same issue when you are selling a stock – there is a buyer, and thousands of other holders choosing not to sell.
Daphne: But professionals make mistakes, don’t they?
Scott: Absolutely. It’s not an exact science. But over the long term, my belief is you are better off investing with a professional manager than competing against them.
Daphne: Thank you Dr. Lummer, and this concludes this week’s Market Matters broadcast.