“Individual investors predictably flock to stocks in companies that are in the news.” – Daniel Kahneman
Apple shares took a huge dive yesterday after the company’s future guidance came in much lower than expected (at least that’s what everyone keeps saying…who knows the reasons why investors buy and sell companies immediately after they release earnings reports).
Apple stock is no stranger to large moves in price following earnings releases. I looked at the stock performance of Apple the day after every earnings announcement (they report after market close) going back to the first quarter of 2009 through yesterday.
Here’s what I found:
- Average gain the day after an earnings announcement: 4.1%
- Average loss the day after an earnings announcement: -4.1%
- Biggest loss: -12.3%
- Biggest gain: 8.8%
Looks like a binary event to me. Good luck guessing how investors are going to react to the news.
Sometimes the past performance matters. Other times investors only care about forward earnings guidance. Who knows why investors get so worked up about one quarter’s worth of numbers, either backward looking or forecasted into the future.
This is what you get with individual stocks. The market as a whole can be extremely volatile, but it’s nothing compared to what can happen to an individual name on any given day.
As the old saying goes, “It’s not a stock market. It’s a market of stocks.”
The potential for large gains draws investors to individual stocks while the large losses are what generally keep investors away from the markets after the fact.
The textbook risk definitions they give you in finance class are systematic and unsystematic risk.
Unsystematic risk refers to specific company or industry risks. If you had only one stock in your entire portfolio, you would be putting your money in jeopardy by placing all of your wealth on that one company’s inherent risk factors. If the company goes bankrupt, you’re out of luck.
Unsystematic risk can be resolved through diversification. Diversifying by adding more securities, asset classes, markets and geographies takes away the unsystematic risk that a single investment will take down your entire portfolio. This is an easy risk to control.
Systematic risk refers overall market risk. It’s also known as undiversifiable risk because it is impossible to avoid if you are invested in the markets. The financial crisis in 2008 is a prime example of systematic risk as nearly all markets went down in unison. Cash and treasuries were pretty much your only safe havens.
The only reason you need to worry about systematic risk is if you need to use funds from your investment portfolio in the short-term or if you don’t have the stomach for handling large losses.
If you’re going to invest in individual stocks you need nerves of steel for those times when the stock trades based on its unsystematic risk factors.
It’s hard enough for investors to deal with systematic risk, so make sure you understand the individual company dynamics before making those investments. You get higher risk and the possibility for higher rewards, but it doesn’t come easy and it’s not guaranteed.
Now for a quick tangent on Apple:
I find it hilarious that after every earnings announcement the media takes turns telling Apple how to run the company better. This is no different than the ball boy telling Peyton Manning what plays to run in the Super Bowl.
Apple is one of the largest, most innovative companies in the world for a reason. Even though their recent numbers disappointed traders focused on the next couple of weeks according to Daniel Gross (@grossdm) one out of every 140 people on the planet bought an iPhone in the last 3 months of 2013 alone.
But please tell me more of your thoughts on how Apple should come up with a new corporate strategy.
For what it’s worth, I just got a new iPad Air a few months ago and I am constantly amazed by this beautiful piece of technology. I can use it for email, surfing the web, TV shows, movies, music, writing, reading books and the list goes on. The screen quality is unbelievable and it’s extremely lightweight.
This has nothing to do with Apple from an investment perspective. It’s just that sometimes people forget how far we’ve come in terms of technological advances considering Apple literally invented the tablet market in early 2010 and the smartphone market in 2007. These are two devices that I now feel I cannot live without and they weren’t even around less than a decade ago.
Some thoughts on Apple: It’s still growing. A lot (Avondale Asset Management)
Why nothing Apple does is ever good enough (Wired)
Follow me on Twitter: @awealthofcs
Another way to think when buying individual stocks is to consider them as money spent like money spent on a vacation or an expensive meal. It’s gone. Then if they do well, you’ll be happy. If they do poorly, it doesn’t matter because you never expected to see that money again.
I bought some stock in an oil company under that frame of mind many, many years ago. Within 2 years it had lost half its value. I didn’t sell it though. It’s paid itself out several times now in dividends and I think I’ll have to donate it to charity if I ever want to get rid of it because the capital gain is huge.
I’m sure the money would have been better invested in a “buy-the-entire-market” index fund, but it hasn’t done too badly the way it is. And I had an emotional motive for buying it that is still satisfied by that decision today.
As for Apple, you’re right that it’s fun to watch the pundits try to outguess the empire. I guess they have to talk about something!
Yes, I think getting your frame of mind right before you buy a stock is very important. You make a good point about defining your time horizon. Generally, the longer you hold a stock the better your performance, but it’s not set in stone. Many stocks have languished for years and never reached their previous peaks. I think it also makes sense for investors to benchmark their individual holdings to a total market fund to see if it’s worth all of the effort.