The truth behind 50 stock market rules of thumb

It’s hard to stay calm when everyone around you is in a panic and bolder yet to be investing millions in the face of a stock market collapse.

That is a long remembered lesson from a few days after the Black Monday stock market crash of Oct. 19, 1987. I was interviewing B.C. entrepreneur Jim Pattison, the rags-to-riches Vancouver tycoon, who kept interrupting the interview to take calls from his broker. In each case, he was buying big chunks of stock, mostly in blue chip U.S. companies.

The main Dow Jones index in New York had lurched the previous Friday and then dropped a record 23 per cent on Monday. The TSE 300 has fallen 11 per cent. With everyone bailing out he was buying. That was brass.

Pattison shrugged and said deals like this didn’t come along very often — great companies with great businesses at a knock down price. “If you’ve got cash, it’s a good time to buy,” he said.

It turned out he was dead on as markets quickly recovered. His buy low and sell high strategy is a pretty common investing phrase, but to apply it in the face of that sort of environment takes acumen, independent thinking and conviction.

Stock Market Rules (McGraw Hill $27.95), now in its fourth edition, takes a closer look at that saying and 49 other well-known investment axioms. Author Michael Sheimo looks at market movements and historical data to show which ones work and why.

You’ve heard of most of them:

Sell in May and go away: You’ll lose 60 per cent of the time, he says. Instead of investing, you’re really betting on timing.

Let winners run and sell the losers: Be careful how you define a loser. Just because a share price dips doesn’t always mean a company is going the wrong way.
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A $2 stock is more likely to double than a $200 stock: A share trades at $2 because it has higher risk. It’s more likely to go to zero than $4. Good companies grow in spurts. One share of Warren Buffett’s Berkshire Hathaway cost $3,000 (U.S.) in 1990. One share was trading at $167,780 needs on Friday, doubling nearly six times.

The common thread is that there are varying degrees of truth in most of the sayings, but they aren’t as simple as that.

Here are few other ideas from the book:

  Buy and hold forever is a misunderstood phrase: This one, attributed to Warren Buffett, is often interpreted as buy stocks and hold them all forever. “He is not saying buy any stock and hold on forever. He’s (saying) before you buy the stock, know it well.”

  Share buybacks aren’t always a good idea: Apple announced a plan to spend up to $60 billion on share buybacks as it released its earnings two weeks ago. Buybacks reduce the number of shares, pushing up earnings per share. The effect is often temporary, Sheimo says. Companies don’t always follow through with the plan and the buybacks may be timed to boost share prices for management bonuses and stock options. It also means the company can’t find anything better to do with the money.

  Follow the pros: Peter Lynch, the great manager of Fidelity Investment’s Magellan Fund in the 1980s called money managers “the blundering herd,” says Sheimo. Just because they are all buying the ‘next’ Apple, doesn’t mean you should follow them. “It’s better use of your time to learn why the institutions like or dislike a stock,” he says. “Why do they like Amazon or Google?”

  There’s always a Santa Claus rally: Most years see stocks rally in November and December. It’s the buying season between U.S. Thanksgiving and Christmas. People are spending money, consumers feel good and “it’s only natural that the buying frenzy would extend to the stock market,” Sheimo says. They are also looking ahead to the New Year. He cites research showing that between 1990 and 2012 stocks rose in December 81 per cent of the time.