An irrational fear of picking dogs

Over the weekend I wrote an article about the current bull run in the UK stock market and shared my personal thoughts regarding its likely duration. In truth, guessing the direction of stock markets is a bit of a mugs game. Not dissimilar to predicting the weather.

Whilst I am sure much of the UK has suffered from the much hyped storm this morning and last night, where I live it's a nice sunny day with a light breeze. Of course it's possible that the storm is currently making it's way towards us, but I won't hold my breath. Interestingly, although forecasters are rarely able to accurately predict even a few days in advance, it never seems to deter them from predicting the outcome for a year or even further out. It wasn't so long ago that climate change experts were predicting that Britain would soon have a climate akin to the South of France and that mild winters would prevail for years to come. Well this summer wasn't too bad, but if the past three winters have been mild then I'm not looking forward to a severe one.

Anyway, I digress.

In the article I wrote over the weekend, I mentioned again that the Financial crisis and subsequent recession had provided the investing opportunity of a lifetime, a view  I expressed at the time.

I noticed today that Pendragon released a trading statement. It's a good statement which says that profitability for this year is materially above expectations, and that they are cautiously optimistic about 2014. The shares are currently around 40p.

Of course during the height of the panic, unbelievably the shares were driven down to 1.5p. A £1000 investment at that point would now be worth around  £26,600.

This brings me to a more general point about investment strategies. It appears to me that many investors are too fearful and cautious about individual losses whilst ignoring the possible exponential gains from buying a small basketful of such shares.

Consider buying shares in ten companies that looked like basket cases at the height of the crisis when they were at or close to their nadirs. Let's imagine you bought PDG, JSG, HRG, TCG and AVS(a share I currently hold). A £1000 investment in each when they were at or close to their lows would now be worth £26,600, £11,000, £16,000, £10,000 and £11,000 respectively (please note that I haven't checked the exact lows, but I am quite sure that the figures are pretty accurate from memory). That's a whopping £75,600 from a £10,000 investment. Let's assume that the other five picks went bust and you lost £5,000. In reality, with reasonable stock picking ability and common sense, you are unlikely to pick five companies that go to the wall.

In fact it appears to me that many investors are totally irrational regarding risk.

Put simply, imagine tossing a coin 10 times, and it's £1000 per go, Heads you win £5000 and tails you lose your £1000 stake. You only need to win twice to break even. Nobody in their right minds would offer you such good odds where the chance of winning is 50%. If you have proven yourself to be a reasonably good stock picker then of course your chances are undoubtedly greater than 50%.

Psychologically it's difficult to take a loss, no matter how small, but actually with a small basket of such shares the fear of loss is totally irrational.