How You Can Crush the Market’s 130% 10-Year Return

There was a nice piece on – you guessed it – CNBC earlier this week, about how an investor who bought the S&P 500 the day before they shut the doors for good at Lehman and held on ’til today would now be up more than 130% on the position, while earning about 11% a year on their stake.

CNBC also points out that it was a scary trip up the mountain as the markets continued to decline for another six months after Lehman Bros tanked – call it “L-Day.”

Factually, they’re not wrong: Those returns are what they appear to be. And the volatility was insane, with sharp countertrend rallies being crushed in short order by waves of selling.

You could reasonably call a lot of that return “combat pay” for those brave enough to hang on.

130% over 10 years isn’t bad… but it’s still not really enough for all the risk that you took along the way.

In fact, indexing rarely gives you enough return to compensate for the risks you take when investing in stocks.

I know a way you could make four or five times what the S&P 500 would – with far less stress, too…

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Consider someone who listened to Jack Bogle, Warren Buffett, and all the other pro-indexing pundits and professors two decades ago: It’s been a long journey, and money has been made…

… but has it really paid off?

I mean, in that time, investors dealt with the Internet craze and ensuing dot-com bust, hanging chads and the Supreme Court crowning a president, the September 11 attacks, and the ensuing wars in Afghanistan, Iraq, and half a dozen other global hotspots.

We’ve had the credit bubble expand and collapse, a global recession so scary and deep that everyone was too freaked out to actually call it a depression, a sluggish “jobless recovery,” the miserable, bitter 2016 elections, and now stomach-churning geopolitical uncertainty.

All that – and just 130% to show for it.

So did index investors get paid for taking risks? The only answer I can give you is “No.”

Buying and holding the S&P 500 for the past two decades has returned about 5.3% per year on average. That’s not enough. It’s an okay way to stay rich if you already are, but no one ever got rich that way, which is sort of the main idea behind this whole investing thing.

The 11% over the past decade is a lot better to be sure, but I have to wonder why anyone would suffer pants-soiling drawdowns and never-ending climb up the Wall of Worry… for returns that are, meh, okay but not fantastic?

Why not do what the super wealthy investors do? Focus on buying good companies at great prices and own them for a long time?

Let’s take a minute and see what a hypothetical investor – let’s call her Ethel – could have done with her money just before “L-Day” in 2008 that might have made her much richer ten years on.

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If, back on L-Day, our Ethel had thought twice, applied the same tools that Warren Buffett and “smart money” players like Seth Klarman use to evaluate stocks, and used those tools to pick stocks to buy and hold, her profits would’ve been a great deal better.

She could have bought shares in Hormel Foods Corp. (NYSE: HRL), for instance. The stock was cheap enough. It was trading at an enterprise multiple of less than 8, and the company had a classic “fortress balance sheet.”

Now, its products are not exciting (“Vienna sausages, anyone?”), but I can promise you I have some Skippy peanut butter in my pantry because, at least according to my wife, I still eat like a 9-year-old boy. And you’d better believe there is some Spam in our hurricane supply box.

A mere financial crisis isn’t going to knock out a firm like Hormel – what, are people going to stop eating? – and Ethel certainly wouldn’t be paying much for their long, impressive history of producing free cash flow.

If she’d bought in 2008 and held through this morning, Ethel would be sitting on an unreasonably good 442% gain on a boring company that slings Spam to a grateful planet.

Banks are another great example.

They were of course in the garbage can back in 2008 – and heading even lower in the months that followed.

If Ethel stopped and looked for the baby that got thrown out with the bathwater, she’d find a lot of money to be made.

Where would you find those? Out in flyover country, where smaller, regional banks did virtually none of the stupid lending that their big-city “Too Big to Fail” brothers did.

But they certainly got dinged like the TBTF banks, and shares could be had for a song.

Great Southern Bancorp Inc. (NASDAQ: GSBC), for instance, is based in Springfield, Missouri and has been around since 1923.

Even in 2008, Great Southern did basic common-sense banking, made conservative low-risk loans, and generally did not take stupid, stupid risks in pursuit of an extra 10 basis points.

The stock has risen a little over 426% since L-Day, 2008 – nearly five times what the S&P 500 provided.

These are just two examples of good companies purchased at unreasonably good prices that would have offered returns several multiples higher than the index return over time.

— Tim Melvin

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Source: Money Morning