This highlights the importance of portfolio diversification. Even the most compelling investment opportunities can be blown off course by unforeseen circumstances that cause material underperformance relative to the wider stock market.
Similarly, stocks can remain materially undervalued even when their financial performance is strong. Housebuilder Redrow’s modest 3.1pc rise and 1 percentage point underperformance of the FTSE 100 since our May tip mean it now trades on a price-to-earnings ratio of just 10. This is in spite of a booming property market that contributed to a 124pc increase in its pre-tax profits in the 2021 financial year.
Redrow’s underperformance so far shows that investors must remain patient when others do not share their enthusiasm for specific stocks. Meanwhile, a long-term time horizon is required when holdings are in the process of implementing growth plans.
Halfords, which this column rated as a buy in March, is an obvious example. The firm’s interim results showed market share gains across motoring products and upbeat sales trends. Moreover, its recent acquisitions seem to place the firm in a stronger position to deliver long-term growth. Yet its shares, although 9.7pc higher, have outperformed the FTSE 100 by just 0.6 of a percentage point since our tip.
Lessons can also be learnt from successful decisions we made last year. Our advice to purchase BP in August went against the investment tide at the time. The firm’s continued reliance on fossil fuels and the inherent uncertainty of transitioning towards a low-carbon future led many investors to shun the company’s shares.
However, its 10.9pc gain and 7.8 percentage point outperformance of the FTSE 100 since our tip show that a contrarian investment approach is a prerequisite for any investor who seeks to outperform the wider market.
Likewise, the opportunities from buying stocks that have had a relatively disappointing history, but which can capitalise on changing industry trends, are illustrated by our advice to buy Sainsbury’s.
We tipped the supermarket, which has struggled for years with no-frills rivals and price-conscious consumers, in March. Encouragingly, its online investment now appears to be bearing fruit. This has contributed to a 19.5pc share price rise and 10.6 percentage point outperformance of the FTSE 100 since our tip. Moreover, its cost-cutting strategy, the development of home-related products and a switch towards digital avenues could pay off in future.
Perhaps the most enduring lesson learnt last year, though, is the “opportunity cost” of holding underperforming stocks. While the FTSE 100 has gained just 3.4pc since we advised readers to avoid fund management firm Abrdn in August, the firm’s shares have fallen by 19.3pc.
Our negative view of the stock was largely based on its high valuation and the challenges faced by active fund managers amid the growing popularity of passive investments. Our experience with Abrdn reinforces the importance of obtaining a margin of safety and purchasing companies in industries with attractive long-term growth prospects.
The process of learning from investment successes and failures is never ending. Indeed, risks such as rising inflation, the pandemic and high valuations among many stocks could cause the market to behave in ways that teach us all new lessons this year.
These events also provide opportunities to use experience gained from events in previous years that, while unlikely to perfectly repeat, should help guide us in what looks likely to be another interesting year for stock market investors.
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