I talk about investing a lot - big surprise.
And every time I have a conversation about some of the stocks I own, I get shocked looks, and someone always says something like, "oh, I could never own that. It's too small. It's illiquid."
The emphasis they put on the word illiquid is similar to that you might put on phrases like "bubonic plague" or "Internal Revenue Service."
Clearly, "illiquid" stocks are loathsome things to be feared and avoided. After all, one of the very best things about stocks is that you can get in and out of positions in seconds if you change your mind, right?
I mean, these days you can buy and sell whole markets in a fraction of a second. So you absolutely must regard liquidity as the Holy Grail, the end-all, be-all of equity investing, right?
If you can't buy and sell gigantic blocks of shares in milliseconds, a company's not worth owning... right?
Well, wrong. This is a myth, and one you've been sold by Wall Street. I'm going to prove it to you.
In fact, when you're done reading this, you'll never sweat a stock's "liquidity" again.
Heck, you may never sell a stock again, at least until you've made ten times your money back.
You certainly won't do it too soon, or for too little money, when you see what I've got to show you...
It's Confirmed: None of Us Is Goldman Sachs
It's great to have goals and ambitions, but let's be real. We may have a couple of bucks to invest in hopes that it'll become, well, a lot more bucks, but we're not exactly Fidelity Investments or George Soros.
I mean, there's no need for any of us to, say, move a million shares of Apple Inc. (Nasdaq: AAPL) at the bid, or dump 500,000 shares of Tesla Inc. (Nasdaq: TSLA) before the markets close.
That's when you need to worry about liquidity.
You and I, we don't necessarily need to sweat it when considering an investment opportunity like, say, an unreasonably cheap community bank we'll want to own for the next five years.
Besides, if you are thinking about liquidity, you are doing it wrong.
[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]
I tell people all the time: "When you buy a stock, think about it like you were buying a business."
Oh, I get wise nods of agreement... and then everyone goes right back to buying Amazon.com Inc. (Nasdaq: AMZN) because the guy on cable TV said it was going to have a great quarter, or Apple because your cousin's nephew's daughter said all the cool kids are going crazy over the new iPhone.
Let's think about buying a business for a minute. Because that is what you're really doing when you're buying a stock - or what you should be doing.
I Won't Buy a Single Share Without Doing This First
If I were going to use a bunch of my hard-earned, non-interest-paying savings to buy a business that I was going to use to pay for putting the kids through college, I would do a lot thinking about what type of business I wanted to be in for a long time.
When you buy a stock, think about it like you were buying a business.
To be successful, I need to own a business that is going to be around a long time and that has products or services people will want and need for decades, not just a few years. And I need it to be profitable pretty much from day one.
So... I'm not going to walk down the street and just buy the first company I see, or that Jim Cramer's fired up about.
I'm not going to base my decisions on what the brokers have to say, either.
I'll listen to what they have to say, of course, and I'll likely evaluate their information, but I'm not taking anyone's advice blindly.
I'll look for a business that, above all, I'm comfortable with, and one that has staying power; products and services that I know people can't live without - or soon won't be able to live without.
I will evaluate the financial condition of the business very carefully; you bet there'll be accountants and lawyers involved. I'll dig into the background of the people that will be managing the business for me.
I'll check the books and financial statements very carefully, watching like a hawk for potential problems or irregularities. I will talk to competitors, suppliers, and customers.
It will be a lengthy process. And I'm not going to let up once I'm satisfied it's probably a good buy.
Oh no...
Because, once I find a candidate, I'm not going to pay a fair price.
I'll want to buy this business at a price that pretty much guarantees me a profit and an unreasonably high cash return. I will be completely and totally unreasonable about the price I am willing to pay to own this business.
Once all the investigating and price discussion is finished, it's still going to take a few weeks for all the paperwork to be done and various forms filed.
In fact, about the only thing I won't be doing is wondering whether I'll be able to buy and sell 200,000 shares before I finish my coffee. Liquidity is the last thing I'm thinking about.
Because when I buy a stock and, by extension, a company, I want to own it for a decade or two.
So I don't need liquidity. I need to have made the correct assessment of the business and pay an unreasonably low price for my ownership stake.
If I do that, I stand a very, very good chance of making an unreasonably large amount of money.
That's how we - as individual investors - should be thinking about stock ownership. Buying a stock because a broker raved about it, or a line squiggled a certain way on a chart, is for the birds... or giant, institutional investors who have no choice.
Warren Buffett once said, "I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years." Lots of people know the quote, of course, and repeat it all the time to seem wise to their friends at cocktail parties.
Once I find a candidate, I'm not going to pay a fair price.
But few practice the Oracle of Omaha's essential wisdom in their daily investing activities.
You own the business - it makes no sense to trade in and out of your ownership stake. Spend some time making sure your buy is sound, and stay there for years. That's an advantage you, as a regular investor, enjoy and the big boys don't.
You'll make a lot more money. Let me show you how much more...
This Guy Is an Economics and Finance "Rock Star" for Good Reason
Professor Roger Ibbotson, of Yale University, tackled the "how much more money" question in a research project not long ago. The co-author of the thrill-a-minute page-turner "Stocks, Bonds, Bills, and Inflation: Historical Returns (1926 - 1987)" lives to examine the long-term returns of stocks and bonds. He uses his ideas and research to manage money at his hedge fund, Zebra Capital.
Ibbotson looked at how liquidity, or lack thereof, impacted stock returns from 1972 through the end of 2016.
High-value, low-liquidity stocks do unreasonably well.
He found, "in this case among the high-growth stocks, the low-liquidity stock portfolio has an annualized geometric mean (compound) annual return of 10.37%, while the high-liquidity stock portfolio has a return of 2.61%."
That's right. Low-liquidity stocks did almost four times better, over the long term, than high-liquidity ones.
High-value, low-liquidity stocks do unreasonably well, too, returning 19.11% against high-turnover stocks, which returned 10.11%.
Ibbotson's conclusion: Both "value" and "liquidity" are distinctly different ways of picking stocks. The best returns come from combining high value and low liquidity, while the worst returns come from high-growth and high-turnover stocks.
Eye-opening stuff, isn't it? When I read and absorbed it, I thought, "here's empirical proof of something I had long suspected: Small, illiquid stocks purchased at unreasonable prices outperform the more popular growth stocks by an enormous margin over time."
Now I live by it. And I think every single individual investor out there should, too.
There's No Way the Big Boys Can Take the Edge from You
Fund managers, institutional investors - the Carl Icahns and George Soroses of the world - they aren't competition here. They simply can't buy enough shares to keep them interested. Our unbeatable advantage does not disappear.
For example, one of my favorite strategies since the end of the credit crisis has been buying very small banks that have solid balance sheets and ultra-safe loan portfolios.
Like you'd probably guess after reading this, I'm happy to own them for years so long as they pay me an unreasonably good return. Why wouldn't I be?
I won't pay more than book value for them, and I don't sell them until they trade at two times book, or we get a takeover offer.
And that happens quite a bit.
You couldn't get Carl Icahn out of bed for 1,000 shares a day.
Many of these small banks are having a hard time keeping up with regulatory and technology costs, so they're actively looking for a larger bank to take them over.
To say it's profitable would be an understatement. Check this out...
In the past year alone, I've seen ten takeovers with triple-digit gains. My latest takeover was First Colebrook (OTC: FCNH), with a market cap of just about $20 million. Volume? About 1,000 shares a day.
You couldn't get Carl Icahn out of bed for 1,000 shares a day. That's a rounding error for a big hedge fund or institutional investor. It's simply not worth their time and effort to get involved.
The edge will never disappear because of over-funding.
The ability to buy smaller stocks is a massive advantage for us as individual investors. We can buy companies that the larger funds can't or won't touch.
We do not have to compete with the large brokers to get the trade done. Some hedge fund manager in a tony Connecticut suburb is not going to drive down our stock price because he has to meet margin calls. An analyst in a cubicle on Wall Street won't be able to issue a buy report that sends you scrambling to buy at higher prices as the public pours in the stock. We can take our time and evaluate stocks as a business opportunity and not just digits on a screen.
It's the best way to make a killing: stress-free. There are no predators in the high-value, low-liquidity jungle.
Those "illiquid stocks" that send people screaming for the hills can be your best friend.
Think of it this way: You have two stocks with outstanding prospects. One can be sold at any time within seconds. One is less liquid, and it will take several days to sell all your shares at advantageous prices.
Which one will you sell to meet some short-term cash need? Which one will you leave alone to let time and value do their job?
Illiquid stocks are like a money stash... in a strong lockbox, wrapped in barbed wire, guarded by a moody rattlesnake. And guess what: The snake's not leaving until you've grown the money inside ten times over.
Fact is, you're far less likely to take the money off the table too soon, and walk away from unreasonable profits, than you would be if it were in piggy bank.
These companies can be tough to find, no doubt. There's a long, difficult process of investigation and analysis to find even one company worth investing in.
And if it sounds too tough or boring to you... Well, I love it. And in a few weeks, I'll be doing it for you, too.
Stay tuned...
An Incredible Win Rate: Since April 28, Shah Gilani's Zenith Trading Circle subscribers have had the opportunity to make average gains of 44% per day (including partial closeouts) on his recommendations. His win record is insane (in a good way). You've got to check this out - just click here.
Follow Money Morning on Twitter @moneymorning, Facebook, and LinkedIn.
About the Author
Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of Peak Yield Investor.