When I’m investing, I prefer to put my money in individual stocks, rather than buying indexes. I have three reasons for this. The first is that I think that I can get to know a single company much better than I can know the constituents of a broad index. The second is that buying an index through an ETF typically incurs fees that buying an individual stock doesn’t. The third is that I think that I can do better over time by buying individual stocks than by investing in an index.
That last point is controversial. According to Charlie Munger, almost nobody can outperform an index. But Munger’s point isn’t that buying individual stocks is unlikely to generate better results than buying an index — this exact approach has worked well for him and for Warren Buffett. It can also work for a monkey. Rather, Munger’s point is that trying to make money by buying and selling stocks at different times is unlikely to succeed.
By way of illustration, here are three UK stocks that have comfortably outperformed both the FTSE 100 (which has returned 12.49%) and the FTSE 250 (which has returned 15.42%) over the last five years. And here’s how they’ve done it.
The first stock is Halma. The company’s share price implies a market cap of around £9bn and the stock is a member of the FTSE 100. Since March 2017, Halma’s share price is up 153.46%.
The reason that Halma has outperformed is that the company has grown its earnings substantially over the last five years. Halma’s net income has increased by 100% and its earnings per share (EPS) has increased by the same amount. As the company’s earnings have increased, the share price has gone with it.
Another stock that has outperformed the indexes is Electrocomponents. The company is also a member of the FTSE 100 and its share price has increased by 113.45% over the last five years.
As with Halma, the increase in share price can be attributed to growth in underlying earnings. Electrocomponents has grown its net income by 100% since March 2017. Unlike Halma, however, the company has issued more shares, meaning that its EPS is only up 89.42%. But it has still comfortably outperformed both the FTSE 100 and the FTSE 250.
The final stock is Ashtead Group. The company has a market cap of around £24bn and is another FTSE 100 stock. Since March 2017, the company’s share price has increased 223.63%.
Ashtead has increased its net income over this time by 91%. But unlike Electrocomponents, the company has also been buying back shares. The result is that the company’s earnings per share (EPS) has increased by 113% over the same period.
What each of these stocks has in common is significant earnings growth. Whether or not they will continue to outperform is an open question, but I’d take any of them today over the index. Over time, however, I think the stocks that increase their earnings faster than the average will outperform the overall index. Identifying which companies will do this isn’t entirely straightforward. But I do believe that there are cases where it’s possible. That’s the moral of Charlie Munger’s story. And it’s why I’ve been buying individual stocks for my own portfolio.
Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Halma. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.