Sears Stock Will End Up At $0

I have been mulling over one of the seeming paradoxes of investing: Stocks that are trading in the cheapest quintile according to book value go on to outperform the other four quintiles combined by 2.5% annually over the subsequent twenty-year measuring period. It is this insight, coupled with the construction of client portfolios following this principle, that made Benjamin Graham a millionaire quickly and earned him the nickname “The Dean of Wall Street.”

And yet, Peter Lynch also stumbled upon an important insight–stocks that fall more than 50% in a three-year period go on to underperform the S&P 500 by almost five points annually over the coming decade. This insight was one of the gems of his work “One Up On Wall Street” and explained why most of his successes at the Fidelity Magellan Fund came when he purchased companies trading in the vicinity of the then-existing fifty-two week highs.

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Clorox Stock In A Blue-Chip Portfolio

Since June of 1998, Coca-Cola stock has returned 2.5% annually. I always keep that figure in the back of my mind, as it is a harsh reminder that getting the company right is never enough–you can’t mess up the overvaluation and drastically overpay. In a way, that 2.5% is actually an incredible testament to the enduring strength of Coca-Cola’s beverage portfolio, as the valuation shifted from 62x earnings to 19x earnings over the June 1998 through September 2015 measuring period. The fact that you were able to come close to keeping pace with inflation, despite paying almost triple what the asset is worth, is actually impressive in light of the overvaluation amount.

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