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(lorenzo rossi/Getty Images/iStockphoto)
(lorenzo rossi/Getty Images/iStockphoto)

STRATEGY LAB

Want investing upside? Be ready for controversy Add to ...

When you invest in exciting long-term growth ideas, one way to gauge the upside potential is by how many people think you’re stupid or crazy. If people aren’t willing to argue with you about a call, there probably isn’t much upside. On the other hand, if you want to buy stocks that have huge upside potential, I think it’s an absolute requirement that you’ll be called every name possible.

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Look no further than the comments section in the online version of any article I write about stocks such as Netflix, Facebook or Tesla Motors. I’ve seen people call me all kinds of names, or even suggest that publishing my opinions the way I do should be illegal. But if all of the comments were sunshine and roses, it would be a sign that the upside I think exists doesn’t really exist at all.

Stocks go up when people think that business prospects have improved compared to their prior expectations. It’s that simple. Sure, you can get a lot more complex by looking at short-term trading psychology where traders are trying to predict what other traders will do in the near future. But once we move past the short-term noise, a stock will move up or down based on how investors feel about its future. If people feel better about a stock because of an actual improvement in the business, the stock goes higher and stays higher. If people get fooled into believing a business has stronger prospects when it really doesn’t, then the gains are short-lived since the truth is eventually understood by the market.

When it comes to long-term investing, I look for stocks that are making big differences in how an industry operates.

Assuming that I’m right on any particular call, it is the folks who currently think I’m crazy who are responsible for my future upside in a stock. I can only make oversized returns if I end up being right against a lot of people who don’t buy into my way of thinking about the future earning potential of a business. The more names I’m called, the more I see it as a sign that the payoff will be quite large.

In the late 2000s, I published a “sell” recommendation on a small Canadian manufacturer of fibre-optic components for the telecom industry. In my opinion, investors had been sold a story that could never pan out. Since I knew the industry better than most of the investors, and I had a strong network of professionals to help me with my due diligence, I was very confident. That didn’t stop one client of our firm, who was a big shareholder, from calling me up and yelling at me. He’d done his own digging too, and his PhD contacts were smarter than mine, he thought. He was wrong, and the stock soon came crashing down. If I hadn’t understood that I needed people to disagree with me to have a worthwhile call on a stock, I might have been bothered by what happened.

Today, I’m invested in Facebook, despite crowds of people who feel that it’s bound to fail as teens abandon the social network. But we know people are social creatures, and there is no meaningful competition for Facebook today. I’m invested in Netflix because I believe online delivery of video will be the primary way people watch TV in the future. Yet there are scores of people who think cable TV will never die. Most of the growth-oriented technology stocks I invest in are ripe with controversy. Without controversy, there is no opportunity. In a theoretical world where everyone shared my opinion, these stocks would already trade much higher.

I’m certainly not always right. I’ve made plenty of incorrect investing decisions over the years. Each time, whether I was right or wrong, there were crowds of people who disagreed with me, and it used to bother me. But as soon as I realized the market is built on conflicting opinions, I stopped worrying.

If you’re going to invest in stocks, not only do I recommend you adopt a long-term focus, but start to expect people to strongly disagree with you – and look forward to it. You can safely ignore the amateurs who hurl insults – instead, sidestep emotion and focus only on the business rationale behind an argument. You’ll become a better investor.

 

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