Why three to five years?

We often talk about the core ingredients to investment success; focusing on buying good stocks at a discount to their intrinsic value (the price you pay determines the return on your investment), holding the issue for a reasonable time frame (3-5 years) and most importantly keeping your emotions in check during “Mr. Market’s” emotional mood swings. When we buy shares in a company’s stock we typically have a price return target of at least 100% over a 3-5 year time frame. This results in an annualized return of 14.87% over 5 years. While not a “knock it out of the park, homerun” return, it is still bests “Mr. Market’s” long run average by more than 200 basis points. Over three years the annualized return comes in at approximately 26%. Now we are in Babe Ruth territory.

The Investment Landscape

So how many stocks actually double over a 3-5 year time frame? We decided to take an un-scientific (realizing that this is just a snapshot in time) lay of the land and screened a universe of more than 9000 companies to see how many doubled in price over the last 3 and 5 year periods. The results: An investor selecting stocks using the dart throwing method would have had an approximately 20% chance of picking a stock 5 years ago that subsequently doubled over the next 5 years. This results in about 2000 stocks. Running the same screen over the last three years an investor would have had slightly less than a 20% chance of hitting a home run over the subsequent 3 years.

Applying a slightly more rigid criteria we decided to go a step further and run the same screens on companies with market caps greater than $500 million, and average daily trading volumes greater than 250,000 shares (to weed out “penny stocks” and illiquid issues). The results: Using this slightly more rigid screening criteria, an investor would have an approximately 33% chance of picking a double 5 years ago. Three years ago, the investor would face a 28% chance of choosing a double. While these screens are not a screaming endorsement for random stock selection, they do show that there have been literally thousands of opportunities to select stocks with 100%+ upside potential over the last 3 and 5 year periods.

Time Arbitrage

What the above exercise attempts to illustrate is the importance of time in the investment process. Some of the household names that more than doubled during the last five years are E*Trade Financial (200%+) and Unitedhealth Group (170%+). While the impatient, emotional investor may have been “scared” out of these high quality names (each experienced several double digit declines over the test period), the patient, value conscious investor would have been vindicated over time with higher returns. A fancy way to define this attention to patience is “Time Arbitrage”. While much of Wall Street and the individual investor community are focused on weekly and quarterly action, the investor with a longer time horizon has an opportunity to use time to his advantage.

About American Money Management, LLC

American Money Management, LLC, an SEC Registered Investment Adviser, manages accounts for individuals, companies, trusts and retirement plans. Minimum account size is $100,000 but investors are invited to try a managed account with as little as $25,000 (AMM reserves the right to withdraw this option at any time). For more information on our managed accounts program, please call us at 888-999-1395 or visit us on the web at www.amminvest.com.

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Disclaimer
The opinions expressed are those of Gabriel Wisdom and Michael Moore and do not necessarily reflect the opinions of American Money Management, LLC (AMM), an SEC registered investment advisor. Clients of AMM, Mr. Wisdom, Mr. Moore and employees of AMM may buy or sell investments mentioned without prior notice. This newsletter should not be considered investment advice. The opinions expressed do not constitute a recommendation to buy or sell securities. Investing involves risks, and you should consult your own investment advisor, attorney, or accountant before investing in anything.