Warren Buffett believes that individual investors are better off investing in low-cost index funds to mirror the market and ensure long-term profits than trying to pick stocks on their own. Fund managers and financial advisors would certainly prefer it if you trusted them with your money, rather than yourself. After all, retail money is often associated with being “dumb money.”
For retail investors who have been making big bets on struggling businesses like Hertz or GameStop in the hopes that they’ll make a fortune on them, they might be better off not picking their own stocks. But that doesn’t mean that stock picking is bad or that you have no hope of beating the market. If you are grounded in fundamentals and aren’t investing in high-risk penny stocks, outperforming the market isn’t an unrealistic expectation at all.
The key is focusing on growth
A good way to maximize your odds of success is by investing in growth stocks. Dividend stocks can be great sources of recurring cash flow, but those businesses are typically conservative in nature and more suitable for risk-averse investors. You’re unlikely to beat the S&P 500 that way, simply because investors won’t be willing to pay a large premium for companies that aren’t generating much growth.
Instead, focusing on businesses that are consistently growing can significantly improve your chances of beating the market. A great example of that is online retailer Amazon. Over the past five years, its stock has soared nearly 400% while the S&P 500 has doubled in value. And five years ago, Amazon was already a huge business that was generating more than $135 billion in revenue and only getting bigger (last year its sales topped $386 billion); this was not a high-risk or small stock by any means. Apple has done even better during that time, rising more than 480% in value.
It’s not just tech stocks that can generate great returns for your portfolio. Drugmaker Eli Lilly (NYSE:LLY) has also outperformed the markets, rising close to 200% in five years. The healthcare company hasn’t even been growing at a terribly high rate — sales of $24.5 billion in 2020 were just 16% higher than the $21.2 billion that it reported in 2016. But stable and consistent growth, along with strong gross margins of more than 70%, helped the company’s bottom line more than double during that time to $6.2 billion.
Here too, there wasn’t a big mystery that there would be some great numbers ahead of the business. By the end of 2016, the signs were already there that its diabetes drug Trulicity (now the company’s best seller) was a winner for Eli Lilly that could help drive significant growth for the company. That year, its sales of $926 million were more than three times the $249 million the drug generated in the previous year. In 2020, its sales totaled $5.1 billion.
Why picking your own stocks isn’t a bad idea
Renowned stock picker Peter Lynch believes individuals have an advantage over Wall Street because they can identify trends ahead of time. While the experts may rely on earnings numbers and upgrades or downgrades to determine whether to invest in a stock, individuals can know ahead of time if a business is likely to succeed or fail if they are familiar with its products and services and whether they will be popular with consumers.
It’s still necessary to research a company and understand its fundamentals before investing in it, but Lynch believes individual investors can use their knowledge of a business to their advantage and outperform Wall Street.
As long as individual investors don’t get caught up investing in high-risk meme stocks or betting on penny stocks that are just burning through money, there’s no reason to doubt that they can’t do as well as, or better than, the so-called experts in the industry. Given the wealth of information on the internet, and the variety of exchange-traded funds (ETFs) to choose from, there’s less of a need than ever for investors to rely on just mirroring the market.
Even if someone doesn’t want to pick individual stocks, ETFs can help target some high-growth sectors. For example, analysts expect the global cannabis market to grow by a compounded annual growth rate (CAGR) of 28% and be worth more than $90 billion by 2026.
Meanwhile, the telehealth sector is growing at a CAGR of more than 37%, and 5G could be among the hottest sectors, growing at a rate of over 70%. Focusing on these segments rather than on the entire market is one way investors can potentially outperform the S&P 500.
Should you pick your own stocks?
If you just want to buy and forget or don’t feel comfortable picking investments on your own, then you are probably better off just investing in an index fund or a broad ETF that covers many different sectors. However, you shouldn’t let the “experts” dissuade you from picking stocks because fund managers and financial advisors will have an incentive in making you believe that you need them to earn a good return.
While that may have been true decades ago, it’s no longer the case now. As long as you are doing your own due diligence and not looking for high-risk stocks to gamble on, then beating the market is certainly doable.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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