What Amazon’s insane 49,000 percent gain can teach you about investing
On top of free two-day package delivery, Amazon has been delivering for shareholders. The company recently marked 20 years as a publicly traded company and made headlines for its astounding 49,000% return since its 1997 initial public offering. Starting at $1.96 per share (adjusted for stock splits), the stock recently crossed $1,000. This 41% annual growth rate would have compounded a modest $1,000 investment into nearly a half-million dollars over two decades.
Amazon’s returns are phenomenal, and the situation offers some key lessons on how you might profit on the next big stock.
1. Amazon’s success is rare — and not obvious
Amazon’s performance is exceptional. As Jason Zweig pointed out in the Wall Street Journal, “From 1926 through 2015, only 30 stocks accounted for one-third of the cumulative wealth generated by the entire U.S. stock market; Amazon was one.” Such massive winners don’t come around very often, but when they do, they’re game changers.
Part of the reason Amazon soared so high is that few investors expected this kind of performance. Certainly Amazon was a dotcom darling at the end of the millennium, but like much of the wreckage of the 2000 bust, it fell from favor.
Share price data from Yahoo Finance
At that time Amazon looked a lot like other ecommerce blowups — eToys.com, anyone? — losing money amid always expanding plans to offer more goods and services. It was never obvious — except maybe to founder and CEO Jeff Bezos — that Amazon would become the dominant force in online retail. If it were obvious, the market would have bid up the stock earlier, eliminating the outsized long-term gains.
Because it’s rare and not obvious, the next monster stock is difficult to find, even for the pros. You could end up chasing wild geese for years or decades. Instead, most investors are best served by buying index funds, or exchange-traded funds (ETFs) focused on a specific industry or company size, where the future Amazons of the world might be hiding.
While these funds won’t give you the same exposure as investing it all in a potential highflier, they will provide some ownership of the best companies, including those high achievers. Even in diluted amounts, those companies help your portfolio shine.
And if you still feel you have keen insight into the next hot stock, keep most of your portfolio in index funds and allocate a little bit to that would-be superstar. If it’s really the next Amazon, it won’t take much to make you rich.
2. Investors benefit from thinking like an owner
While finding Mr. Right Stock is hard enough, it can be even harder to hold on once you’ve found it. Two full decades is longer than many marriages. But it’s an absolutely key point: The only way to rack up Amazonian returns is by buying and holding great companies. That requires taking a long-term view on the company and especially the market, which will bounce the price around, sometimes regardless of how well the business is doing. It’s a simple prescription, but it isn’t easy to swallow.
Perhaps the easiest way to buy and hold is to think like an owner of the business, because you are an owner if you hold the stock. That requires time, energy and a willingness to keep up with the company. It means reading the quarterly and annual reports, studying the industry and watching the trends. In short, it means a lot of work. But that’s part of why the opportunity exists, too. Few are willing to make that kind of commitment.
By focusing on the business as a business — not just a piece of swerving electronic data that could make you money — it becomes easier to continue holding the stock even when the market moves against the position. This focus also gives a great company time to work its magic, and “time in the market” is one of the best predictors of overall returns.» MORE: Calculate how much you should save for retirement
3. Conquering emotion is key
Thinking like an owner can help you focus on the long term, but humans aren’t wired to deal well with loss. While the logical part of your brain says the company is doing great, the emotional side is saying, “The market is selling and you’re crazy for holding on.” Owning any high-flying stock means dealing with loss from time to time, even as you’re on the way to superb long-term returns.
While the chart above shows Amazon’s whole history, the graph below focuses just on the early part of Amazon’s public life. Above, the bumps and twists of Amazon’s early years pale in comparison to the huge run-up in the stock over the last eight years or so. Look closer, though, and there were plenty of investors selling the stock, pushing it to massive losses in the wake of the dotcom bomb. What looks obvious now — Amazon’s dominance — was not so back then.
Share price data from Yahoo Finance
The stock was incredibly volatile in its early years. For example, on April 23, 1999, the stock closed at $105 per share, near its high for the year. By June 1, 1999, the stock had lost nearly half its value, tumbling to less than $53. A near 50% loss in just over five weeks. Then by Dec. 10, the stock was back above $106 per share, albeit briefly. That was before the market really began its downturn in 2000, taking the stock with it. The stock bottomed around $6 in late 2001. While this was still triple Amazon’s closing price on its IPO, it was cold comfort for investors who had been up more than 50 times on their money as recently as two years prior.
Most investors aren’t made for that kind of roller coaster. For this reason and others, many investors turn from individual stocks to Standard & Poor index funds, which still offer solid returns over time. During the same period Amazon spiked 49,000%, the S&P 500 turned in a much more modest but respectable 190%. And while it’s not unusual for a highflier to lose 50% of its value over the course of a year, it’s very unusual for an index to do so, even during a recession.
Still more emotionally satisfying, when an index falls, you have the safety of diversification, the knowledge that you’re investing in America’s best companies, and none of the uncertainty about whether your one stock pick will become the next Amazon or tank miserably.
This article originally published at NerdWallet