Savvy investing is tough. Success requires solid due diligence and constant observation of the economy. However, many investors like to oversimplify a thesis and then buy-and-hold with total confidence.
Since last fall I have received many emails from readers who challenged my assertion that the bull market was finished. On December 31, 2007, I wrote an article Banking Crisis: No End in Sight. Some Seeking Alpha readers passionately argued that banks were in as little trouble as their CEO's alleged - despite the troubling mortgage and commercial loan data I provided.
The constant theme I noticed was that some people bought into stocks like Wachovia Bank (WB) on the general thesis that finance is the engine of capitalism and therefore will be fine in the "long term." This is the same bullish rhetoric I quoted in my article as stated by Rich Pzena of Pzena Investment Management (PZN): "Citigroup is everywhere. It is a massive global franchise that will grow in line with global financial growth …" Try to explain that to the poor investors and employees who have seen WB and C shares erase all gains from the past 16 and 10 years, respectively. That, my friends, is as "long term" as long term gets.
The lesson here proves that developing a general thesis is not enough. In fact, a general thesis is merely a starting point for the savvy investor. The next action step is due diligence, and the following step is constant monitoring of the situation. When investors execute step one and ignore steps two and three, multiyear gains can evaporate quicker than Lake Lanier during a drought.
I can tell investors are ignoring steps two and three when they tell me broad-based statements like, "WB is a steal at 40 because it's already down over 20% from its highs," or, "With WB's dividend, you can just load up the truck and get paid to wait." Wait for what? The stock to go to 15 and the dividend to get slashed or suspended? If you find yourself ignoring important reports displaying a company's exposure to a major problem (e.g., WB's exposure to toxic debt), you are deluding yourself into the land of hope and dreams. And once you start using hope as support for your thesis, your investing days are limited.
Another perfect example of the one-dimensional thesis is Whole Foods Market (WFMI). A very oversimplified thesis states that organics are a growing trend. True. WFMI was the first-mover in the space and delivered an excellent retail experience. WFMI also had nearly zero competition. With those supporting data points plus the awesome financial metrics, WFMI was a screaming buy.
However, over the past several years many world-class companies have entered the still growing market for organic products. Traditional grocers such as Kroger (KR), Walmart (WMT), and Target (TGT) created isles dedicated to organic foods, while other organic retailers such as Wild Oats and Trader Joe's simply attacked the niche - and companies such as Safeway (SWY) and Publix (PUSH) did both. Thus, WFMI lost its first-mover advantage as well as its pseudo-monopoly (i.e., pricing power). Once you add food inflation, rising shipping costs, merger costs (Wild Oats), and decreasing consumer spending, WFMI looks like a very ripe target for multiple contraction and decreasing earnings. But the one-dimensional thesis (i.e., increasing demand for organics) is still intact. If you relied on this sound thesis without due diligence and constant observation, you probably watched 6 years of gains disappear like organic double-chocolate brownie samples on the bakery counter.
So, next time you find yourself conceding to cognitive dissonance and ignoring new data points, take a step back and make sure you're not succumbing to the pitfalls of the one-dimensional thesis. If you are the preventative type (which I highly recommend), then apply your trusty three-dimensional framework - sound thesis, due diligence, and constant observation - during all your prospective and current investments and trades. The added dimensions will blow your mind when you preserve and grow your hard-earned cash.