“Good” companies are generally bad stocks, and “bad” companies are generally good stocks.

Makes sense? No? Good. Because a lot of things in investing are counterintuitive.

#2 The Conventional Wisdom Is Usually Wrong!

That first statement might be highly generalized, but it is true. Here’s the reason: if a company is a good, well-established company, and everybody knows this, you can be certain that a lot of people have already bought into that company’s stock. Pushing the stock price higher and consequentially, lowering its future returns.

To throw in another perspective, if everybody else has already bought into a certain stock, there would be little to no buyers left to push the price even higher, resulting in a disappointing performance moving forward. This is an oversimplification. But you get the idea.

Conversely, stocks of “bad” companies – ones that are currently disliked because of the time’s sentiment, or because of its risky financial situation – are selling on the cheap! Since holders of these stocks have turned into sellers, and nobody wants to touch them, stock prices have been pushed low. And as long as these companies survive and eventually thrive, their stocks will most likely yield higher future returns.

What about Google, Amazon, Microsoft, etc.? Good companies, good stocks…

Here’s my take: A stock of a good, well-established company is perceived to be good, only with respect to, or from the perspective of, its past stock performance; not its prospective future returns.

To have been able to participate in the excellent returns of these stocks, you would have had to buy them sometime around 10 years ago, when they were still seen as a risky bet.

Now an example: The Nifty Fifty of the US in the 1960s and early 70s. IBM, Xerox, Polaroid, Coca Cola, Texas Instruments, among others, were the fifty best companies at the time, having performed exceptionally well in the several years prior. They were the “sure thing.”

So the advice in the late 60s? Just buy the best of the best companies, hold them and never let go. But here’s the punchline: If you bought the best of the best in 1968, and you held them for the next 5 years, you would have experienced a 70-90% loss, simply by holding what were considered to be the best companies in America at that time.

Good companies, bad stocks.

This can also apply to the level of nations. Where “good” stable countries might not necessarily yield good stock market returns, and where “bad” riskier countries could yield good stock market returns.

“Because risk is high, prices are low. And because prices are low, future returns are high.”

Consider the 2000s decade for the US, where, after having two massive crashes (the dot com and the 2008 financial crisis), the S&P500 returned -9%. Imagine, a negative 9% total return for being invested in the US stock market for 10 years. By this point, sentiment over the US has gone bad. People were generally skeptic about touching US stocks; it was a risky bet.

And then the 2010s rolled in; The US Stock Market returned an average of 13% per year, for the next ten years.

All these to illustrate that more often than not, things will unfold in ways we least expect. Investing well is counterintuitive. The conventional wisdom is, by definition, something that everybody knows to be true. And you can’t make good money in a bet where everybody else is on the same side of the bet as you.

So here’s an interesting takeaway: Identify the era’s conventional investment wisdom, and assume that it is wrong.

Back-test this strategy and you’ll see that it works surprisingly well. What was the conventional investment wisdom in the late 60s? – buy and hold the best of the best companies and never let go. Wrong. Conventional wisdom in the US in late 1920s? – Stocks will keep climbing up; worst case was that it would plateau. Then The Great Depression happened. Early 2010s? – US stocks were risky. Result? 13% return per year over the next decade.

Stocks are better than bonds? In the 20-year period from 2000-2020, long term bonds outperformed stocks.

OK, I am not actually saying you should go the opposite direction and bet 100% against today’s conventional wisdom. One can do that for sure, but it would not be prudent.

The more practical and grounded takeaway is this:

Protect yourself from the possibility that today’s conventional wisdom might turn out painfully wrong. Question today’s conventional wisdom. Nobody knows what’s going to happen in the next 10, 20,30 years. And that the best strategy for an uncertain future is to diversify well – to have a portfolio that will be resilient to, and even thrive in, the number of ways the investment landscape could unfold.

Here’s a list of what I think are the current era’s conventional investment wisdom:

1. The US Stock Market is the sure thing.
2. Diversifying internationally is risky, and not necessary.
3. If you are young, you’re stock allocation should be in the 70-100% range.
4. Bonds are enough to diversify; Stocks and Bonds are all you need for a diversified portfolio
5. The 4% Rule [of thumb]. (It might be less. But it could be more)

My guess is at least one of these isn’t going to be true moving forward. What do you think?

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(Source) Ideas and lessons rooted in and learned mostly from:

• The book, “The Four Pillars of Investing” by William Bernstein
  • Reading the book would still be the best, but here’s a 5-min. YouTube summary that covers some of the important points
• Howard Marks’ memos
  • There is also a podcast version of this, called “The Memo, by Howard Marks”