The untold risks of average returns

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This headline might sound confusing at first sight, but behind it is a topic worth thinking about. As one understands what’s behind “average returns”, a portfolio check-up could be appropriate, especially if one is overweight in stocks with past above average performances paired with high valuations. A few thoughts on risk-adjusted investing.

Summary and key takeaways from today’s Weekly
– An average return number of the past is no guarantee for the future.
– Bad series can last longer than thought.
– Be prepared for that, financially and emotionally.

To make it clear from the beginning, my intention is to stress the importance of risk-adjusted investing. Investing is about taking advantage of higher probabilities, respectively favorable risk and reward situations while ideally one stays out of those games where the odds are not in one’s favor or the expected returns do not compensate adequately for the risks.

No one will ever be 100% right, though.

But it is possible to improve one’s odds by avoiding stupid things like following too crowded stocks, despite their seemingly never-ending run-ups and despite passive investing via ETFs throwing money at them continuously. For me, it is likewise not wise to assess a company’s quality solely based on its history (see my thoughts about the Lindy effect here).

We have seen in 2022 what can happen to the infallible big tech stocks and how they pulled down the indexes due to their high weightings. Or those names which stocks dropped and then cut their dividends – despite their “proven histories”.

There are always periods of exaggeration to the upside, but also to the downside, meaning a trend can last much longer than one expects, even if one’s right long-term.

source: Greg Montani on Pixabay

To mitigate those risks, assuming with stock picking one can only lose (I’m hopefully proving them wrong), many claim to be okay with average long-term returns and by playing it seemingly safe. Thus, they choose the “safe” option of ETFs and / or stocks of companies where the underlying business is far from interesting to the upside, but at the same time not free of risks.

This is important to understand: seemingly safe is not risk-free!

The above is exactly the other way around like not only I see it, but every serious stock picker will agree with me. You do not want to have limited upside and fair downside, but high upside with limited downside to – on average – achieve a great investment return.

This is the correct approach to stock picking from a mental standpoint and not “it’s a risky and losing strategy, I want safety”.

I have already written about this topic from a more cyclical perspective (e.g. here, here or here, just to name a few) and my longer time readers know about my risks-first approach in stock analysis.

Today, another piece with food for thought on this topic.

The average total return of my best stock ideas is ahead of the S&P500 and the iShares MSCI World ETF. With my risks-first approach (paired with high upside), I am able to find stocks with great returns.

both as per 27 March 2024 market close – since August 2022

If you struggle to find high-quality stock ideas, let me inspire you. As a Premium or Premium PLUS Member, you receive my exclusive research reports with my best and market-beating stock ideas.

Why and how to survive average returns

From my personal observation, especially ETF Investors assume that average returns are what they can expect on a yearly basis over the long-term.

While most of them know that this won’t be the case exactly in every year, my impression is that the risks of really bad years or longer periods of below average returns are pretty much underestimated.

We have experienced at least ten years with above average returns. Even more pronounced regarding the big tech stocks.

So what should follow next for the equation of average returns to be correct?

As the last real financial crisis with a brutal bear market is already 15 years behind us, many have never experienced such a downswing. Likewise, the majority does not know what a ten year sideways market is from personal experience (except they invested in emerging market ETFs).

Many of my readers already know this screenshot below.

But for my newer readers, I wanted to show it once again, because it is so important.

There have already been several periods of ten or even more years with zero returns – before taking into account inflation of course.

source: own presentation

Note: I want you to think about the following not just in the index category, but also sector-wise, e.g. tech stocks, AI-stocks, whatever stocks as a group that’s currently en vogue and seen as infallible.

While it might be an extreme view and look cherry-picked, stock market tops respectively late stages of bull markets are the times when many “defensive” investors enter the stage. That has to do with bad memories or experiences of the past as well as the known approach of “wait until the dust settles” during turbulent times.

I do not want to call out for a crash – that’s not my style and honestly not even what I am expecting. Otherwise, I wouldn’t publish research reports with stocks ideas. For me, it is not important to spread fear like crash prophets do, but instead to discuss certain situations from a risk and reward perspective.

Risk-adjusted and return-focussed are the keywords.

That’s what serious investing is about.

Confidence needs very much time to be built, but just the proverbial blink of an eye to be eradicated.

We do not even need a real crash – which I am not expecting anyhow, because the problems are in the public sector this time, not in the private like was the case in 2008 or the famous meltdown of 1929.

That’s why those who draw parallels between 1929 and today have no clue what they’re talking about, as public finances were in order back then in the US, unlike today.

The government not only had very low debt, but even a budget surplus in 1929 and 1930, i.e. at the time of the stock market crash!

source: FED St. Louis (see here)

Why is this important?

I am not an economist. But I know there is / was a traditional way of investing: in good times equities, in worse times (for safety) bonds, preferably from the government.

But this traditional “flight to quality” does not work anymore!

This is important to understand.

Going a step further, please see on the bottom left the debt to GDP ratio (16% only in 1929 compared to more than 120% today) of the federal government and on the bottom right the trending federal deficit.

So ask yourself the question, if you thought we are close to a 1929 top: while it was an easy choice historically to switch from equities to government bonds – the traditional safe haven to park money – would you do it this time again? Would you feel that safe?

For me, the answer is clear.

Low debt and a budget that’s in order is a completely different setup compared to hopelessly over-levered with even rising deficits.

source: History in charts (see here)
source: The Balance Money (see here)

Stocks have become the flight to quality.

Forget this nonsense with gold or properties (in Germany called “Betongold” which is “concrete gold” in English) as they are not big respectively liquid enough. Also, many professionals are not even allowed to invest directly in them or under certain limitations.

This is why I think that the biggest stocks by market cap got so big. The companies have clean balance sheets with lots of net cash, low competition, high-margin businesses and most of them are buying back stocks.

And they are highly liquid in trading.

But the upside is rather limited from a fundamental perspective. Most of them have even abysmal growth rates compared to their lofty valuations.

No sane investor pays a 30x multiple for a barely growing company that’s even facing challenges – I am talking about Apple (ISIN: US0378331005, Ticker: AAPL).

The time to buy it was in 2018 at an EV / FCF multiple of 9x when everybody thought Samsung and the Chinese brands would outcompete them with cheap products, not understanding that Apple is a mix of hardware, software and services with one of the most loyal customer base there is. An Apple user does not care whether there’s a Samsung or LG phone or laptop 100 or even 200 bucks cheaper.

At the same time, while growth temporarily came to a standstill, they were buying back 10% of stock p.a., compared to only 2–3% today.

Here’s an old video (see here) from the time at my old employer where I discussed with my former colleague the Apple case when nobody was interested in it. One German site was even making fun of us.

source: Seeking Alpha (see here)

Apple started to trail the S&P 500 meaningfully.

This can happen to other tech stocks, respectively everything with an unfavorable mix of low-growth, but high valuation due to excessive expectations, too.

For example, many consumer stocks with barely any growth, but levered balance sheets – traditionally also defensive stocks with decent returns even in bad times – lost their status. I’ve written about them here.

The same will likely even sooner or later apply to the other big tech stocks, because they have become very huge. There’s a natural limit to where growth can go.

That’s why I’m staying out, despite note expecting an overall stock market crash.

What I want is true organic upside (with limited downside) based on a favorable development of the underlying business.

Just think of prolonged periods of zero returns over a time span of ten years or even more! This does not have to, but it can happen.

One can sit out a weaker year or two. But above that, it gets tough.

Such a scenario – not unrealistic – is good enough to challenge market participants mentally on the extreme side. It starts with “it’s just a correction” to “buy the dip” until they lose patience. With smaller organic growth stories or interesting turnaround situations, this can be avoided.

That’s why I am an advocate of picking individual stocks, mostly small- to mid-sized. There are several advantages to that:

  • you know what you own (you should!), not only by the name, but regarding the underlying business and its development perspectives
  • aggressive buybacks can really make a meaningful difference, instead of just being cosmetics
  • the bonus option of a takeover bid
  • you can decide about each and every position size
  • you can leave out the absolute garbage to limit your downside potential
  • with positions that have the chance for way above average returns, you can keep even a decent cash position to be able to strike when appropriate

These are only a few, but for me the most important arguments.

You do not want to have limited upside and fair downside, but high upside with limited downside to – on average – achieve a great investment return.

From a risk and reward perspective, if you want to make money, you need to look for better priced opportunities with realistically much more upside potential.

My strategy is to have a portfolio of up to 15 positions where say 10 have the chance of becoming a multi-bagger, maybe one or two even ten-baggers. This is far more likely to result in above average returns – even if only there’s just one jackpot pick – compared to a portfolio with a mix of 50 highly valued stocks and even several perpetual losers (because they were great in the past).

Again and as said, everything on a favorable risk and reward basis.

Now, a few thoughts from the statistical view point.

An average return number of the past is no guarantee for the future.

This is almost self-explanatory.

But concretely, imagine you’re in a casino playing roulette. Your chance to win by choosing a color (red or black, let’s leave green aside) is slightly below 50% in order for the house to safely win due to the two green fields zero and double-zero in addition to red and black.

After every unsuccessful round, you might think that your chance to finally win increases with every new round, because 48% should result relatively frequently in wins, doesn’t it?

That’s not the case. Every round starts a new. Over a long and statistically significant period, this should be correct. But there’s a catch. Let’s say you choose red. As there is American and European roulette with odds of 48.6% and 47.4%, let’s just say for simplicity reasons 48% or a 1:2.1 chance to win. This means on average every 2–3 rounds – on average – should be a win for you.

But what if the series is 5x lost and then theoretically even 4x won in a row, but you’re unfortunately out of money after round 5?

On average, you should have won.

Practically, you lost everything.

source: Andrew Khoroshavin on Pixabay

Maybe a more practical example is drilling for oil or mining for gold.

Let’s assume that 10% or one in ten drills is successful. Should you put a tenth of your exploration budget into every try? What if the first 18 tries are losses, only to be succeeded by two straight so called bonanza drills with huge finds?

If you’re out of money after round ten, this won’t make you any pleasure.

My message here is not about gambling or position sizes, but the following:

Bad series can last longer than thought – be prepared for that, financially and emotionally.

The problem with averages is that it’s just a sum of all bad and good tries, respectively returns for every year, put together in one basket and divided by the amount of tries or years.

But it does not say anything about the order of sequence.

We don’t know what comes when. That’s the reason why one should be positioned in a way that statistically the odds are in one’s favor – and not in the past.

You can be lucky like over the last ten years with above average returns. You can also have bad luck like was the case in 2022 when all big tech stocks nosedived, while energy stocks went through the roof.

So basically, investing based on average expected returns sounds fine in theory. But you ought to understand the practical implication and be prepared accordingly.

That’s why my members receive ideas with a mix of favorable business setups, ideally an organic growth story paired with a decently low valuation to enjoy both driving forces – growth and multiple expansion. As a cherry on top, here or there, there’s the bonus of a potential takeover. It does not have to materialize, but it’s an option.

Take for example Petrobras (the preferred share) which my members received a report about on 12 August 2023. The stock outperformed the S&P 500 slightly on a price level, but in between we’ve collected 8.2% in dividends on top for an in total strong outperformance in less than a year so far.

source: Seeking Alpha

Or take my so far two best picks for my Premium PLUS members (stock names anonymized, charts since reports were published) which crushed the S&P 500 so far, due to several individual tailwinds.

source: both Seeking Alpha

These are just a few examples. But you can see from my fully disclosed performance charts which are based on all ideas – the best and the less successful ones – that my ideas on average are beating the market.

Rest assured that they also crushed their well-known big competitors from the respective sub-sectors.

both as per 27 March 2024 market close – since August 2022

So, if you’re looking for ways to beat the market and at the same time get some ideas with favorable risk and reward constellations, please have a look at my memberships.

On this site with an overview, you can also read what some of my members are saying themselves.


An average return number of the past is no guarantee for the future.

Bad series can last longer than thought.

Be prepared for that, financially and emotionally.

By becoming a Premium or Premium PLUS Member, you get instant access to all my already published research reports as well as several updates.

Likewise, you qualify for eight, respectively three more exclusive reports with my best investment ideas plus updates on the featured businesses over the next twelve months.

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