How difficult is it to pick the best-performing stocks?
Well, it seems like pretty much everyone is on the hunt for the next big AI stock that’s going to blow up. Will it be Google? Nvidia? Possibly Meta? Palantir? After all, these companies have invested billions into developing their AI tools.
What if I told you the next big AI stock could be a little company called Toto Ltd.
Ever heard of it? My guess is probably not. Toto is a Japanese company that makes toilets. They’re particularly known for their bidet toilets.
What do toilets have to do with AI? They don’t.
Except that recently, Toto stumbled upon the fact that their specific ceramic techniques used to make their toilets can also be used to manufacture bleeding-edge AI chips. Prices for memory chips have soared in the past few months due to massive demand from AI companies, and this little toilet company is taking advantage.
A big investor in the company says it’s “the most undervalued and overlooked AI memory beneficiary.”
The stock is up over 60% since December.
A Japanese toilet company.
If we put aside the traditional, numbers-based argument for why it’s difficult to pick individual stocks. Of which the data is robust.
There’s a crucial philosophical dilemma that also comes with picking individual stocks. The question is simple:
How do you know if you’re good at picking stocks?
Or in other words, how much of your success, or lack thereof, is due to skill versus luck?
Let’s say you were an investor in Toto Ltd. You likely invested in the company because you thought they made comfortable toilets that do a great job of cleaning your backside. You could never have known that they would be the company to stumble upon a solution to AI chip manufacturing.
You made an awesome return. But it had absolutely nothing to do with why you invested in the stock in the first place.
Michael Mauboussin, the author of The Success Equation, gives a great framework for how to go about answering this question:
“There’s a quick and easy way to test whether an activity involves skill. Ask whether you can lose on purpose.”
I can purposefully miss 100 basketball shots in a row if I want to. I can purposefully miss every single putt on a golf course. I could purposefully be bad at my job.
However, am I confident in my ability to pick a list of ten stocks that will underperform the broader market over the next year? Not really.
This is the philosophical dilemma I’m talking about.
Luck and skill are so difficult to untangle because, as Mauboussin puts it:
“Even if we acknowledge ahead of time that an event will combine skill and luck in some measure, once we know how things turned out, we have a tendency to forget about luck.”
This can be a dangerous game to play because taking credit for a positive outcome can lead to overconfidence. Bill Bernstein, an investment writer, has written about the hidden dangers of picking individual stocks:
“The very best way to learn about the dangers of individual stock investing is to familiarize yourself with the basics of finance and the empirical literature. But if you can’t do that, then, sure, what you have to do is put 5% or 10% of your money into individual stocks. And make sure you rigorously calculate your return, your annualized return, and then ask yourself, “Could I have done better just by buying a total stock market index fund?”
And pray that you don’t get really lucky, because if you get really lucky, you may convince yourself that you’re the next Warren Buffett, and then you’ll have your head handed to you when you’re dealing with much larger amounts later on.”
Now, money earned by luck is still every bit as green as money earned from skill. There are no extra points for being right for the right reasons, and people get lucky in the stock market all the time. However, I’m not sure I want to rely on luck as my long-term wealth-building strategy.
For most people, luck runs out at some point.
Thanks for reading!
Jake Elm, CFP® is a financial advisor at Dentist Advisors. Jake a graduate of Utah Valley University’s nationally ranked Personal Financial Planning program. As a financial advisor at Dentist Advisors, he provides dentists with fiduciary guidance related to investments, debt, savings, taxes, and insurance. Learn more about Jake.