Kelly McGonigal, the author of the “The WillPower Instinct: How Self-Control Works, Why It Matters, and and What You Can Do To Get More of It”, addresses the question of why some people have a better ability to devote their life’s energies to hard work, perseverance, and grit than others. Why are some people naturally industrious, able to work long hours without thinking about it, while others will frequently reference that one time they worked twelve hours in an exercise of self pity?
In chapter 2 of her book “Your Body Was Born To Resist Cheesecake”, McGonigal argues that industrious people tend to attach a high degree of risk to each individual action. They think, “If I don’t put on a long day at the office today, I’ll get fired.” Or ‘If I eat that donut, I’ll get fat.” Of course, that mental viewpoint is an exaggeration. One day of low productivity won’t get you fired, nor will one binge make you fat. It’s the repetition of those behaviors on a regular basis that leads to trouble.
You know that John Adams quote from his diary where he wrote “idleness is sweet, and its consequences are cruel”? The industrious ones modify it to “A moment of idleness will bring about cruel consequences.” This exaggeration of perceived risk is akin to an evolutionary shortcut that fosters more optimal behavior–the point of professional, physical, or social self-destruction cannot be reached if the roots are never permitted to take hold.
In other words, developing the habit of personally excising all of underperforming characteristics is a great way to get everything you’ve ever wanted to get out of life. It is very easy, then, to see how this type of behavior could be applied with enthusiasm to one’s investing life. If it is good to remove sloth and gluttony from your character, why not remove that stock down 20% this year from your portfolio? If you tend to believe that the first instance of a behavior leads to the result that ordinarily comes after the repetition of that behavior, then you might also believe that the spotting of one poor investment means that it must be removed immediately otherwise you won’t meet your retirement or other personal investing purpose.
I saw this firsthand in February when I read message boards of ConocoPhillips (COP) shareholders deciding to part with their ownership position in the stock after it cut its annual dividend from $2.64 per share to $1.00 per share and saw its share price crumble from a high of $87 in 2014 to a low in the $31-$32 range at the time of the mid-February dividend cut. It was flunking the “What have you done for me lately” test on all fronts with its falling share price, dividend cut, and evaporation of profits. Between the middle of July 2014 and 2016, you would be hard-pressed to find a silver lining in being a shareholder of ConocoPhillips.
And yet, this type of measuring stick for business performance does not analogize well from the personal realm. If you eat 2000 calories per day, and burn 2,000 calories, that additional piece of 250 calorie cheesecake *is* something that needs to be made up if you don’t want to gain 0.07 pounds. Your future self will have to eat less or move more to undo it.
Likewise, if you’re a slacker with your assignments in the workplace on a given day, you will have to do extra work thereafter to overcompensate for previous underperformance.
What makes an underperforming stock different is that it doesn’t require personal action from you to overcompensate. It is still a “thing in motion” that can remedy past underperformance with future outperformance all on its own. In fact, this is what is statistically likely to happen as 83% of S&P 500 components that cut their dividend go on to outperform the S&P 500 over the subsequent five years (hat tip to Professor Jeremy Siegel for the research on this statistic).
Since its February dividend cut, Conoco shares have gone up 34% while the S&P 500 has gone up 19%. Conoco is off to an early lead, and by February 2021, I still suspect that Conoco will have outperformed the S&P 500 during the February 2016-2021 comparison period. I base that prediction not only the general statistics that this has a four out of five chance of occurring, but also on the specific characteristics of Conoco as an excellent upstream producer that generates very high profits in boom times and sees those same profits evaporate during harsh conditions but is on the balance a money machine.
What is important to recognize is that Conoco’s performance since February was entirely self-propelled. If you sat there and did nothing while the dividend was being cut and the stock price was falling, you got to capture the 34% increase in price since February while a typical S&P 500 stock would have given you 19% over the same time frame. There was no action on your part required to remedy the past.
If you are industrious, you know that eliminating the broomrapes and dodders from your life’s garden is a necessary antecedent to a fruitful harvest. Eliminating the bad as soon as you spot it is great when you are dealing with things that involve your own active participation. But this wisdom doesn’t extend to investing. Reversion to the mean is a powerful concept when it comes to large-cap stocks, and underperformance often means that the highest rate of future appreciation corresponds with the moments when the stock appears primed for pruning.