The investing insanity of trying to find the next Amazon

Amazon.com is the sixth-largest company in the S&P 500 Index by market value. Incredibly, the company wears that crown despite having earned less money than 121 other companies in the previous 12 months.

It’s no secret that Amazon AMZN, +0.39%  is an expensive stock. Even if founder and CEO Jeff Bezos were to capture 100% of the total retail revenue, the company’s price-to-earnings ratio would still be 63! Amazon’s stock has received a lot of attention over the years because its performance has been off the charts while maintaining a nosebleed valuation that has been the envy of the company’s competition.

Amazon is the third-best-performing S&P 500 SPX, +0.38%  stock since going public in 1997 (trailing only Monster Beverage MNST, +0.92%  and Celgene CELG, -0.80% ). Below you’ll see the 38,155% return since its IPO, which is 100 times better than the benchmark index over the same period. Each dollar invested at the IPO has compounded at 35% per year, which I’m pretty confident will not continue. If it did, its market value would exceed $5 trillion by 2025.

Amazon (black) vs. S&P 500 (red)

This massive outperformance has led to an explosion in hindsight bias, with investors fooling themselves into believing Amazon’s ascent was somehow obvious or inevitable. But the truth is this 38,000%-plus return was handed to nobody; it was earned through enormous dedication. Actually, lunacy might be a better way to describe it, being that you had to be some sort of sociopath — void of any human emotions — to earn these monstrous gains.

Below is an incredible chart I’ve shared before, which shows that Amazon’s path to a 38,000%-plus return was filled with heartache, despair and nausea.

Amazon’s gains (green) and losses (red)

Some of Amazon’s losses have been totally insane. The stock fell 15% over three days 107 times. It has lost 6% in a single day 199 times. And it fell 95% from December 1999 to October 2001.

People anchor to Jan. 1 for diets and exercise — as well as investment returns. Every year the clock resets. So below I show the maximum intra-year drawdown, i.e. how far the stock fell from its high in each calendar year. Amazon has had a double-digit drawdown each year since going public and a 20% drawdown in 16 of 20 years. The average is minus 36% (and the median is minus 30%). I wanted to provide a reference point of just how insane this is, so I included the Dow Jones Industrial Average DJIA, +0.09%  (sue me) in black. You’ll notice that Amazon had far deeper drawdowns in every year except in 2009 and 2015.

Amazon drawdowns (red) vs. Dow drawdowns (black)

People waste way too much time looking for the next Amazon, but I get it, it’s part of what makes investing exciting. So if you’re going to search for a potentially life-changing investment, here are a few things to consider:

• A lot of people spend their life looking for the next Amazon. Few people ever find it.

• Sticking to a boring 60/40 portfolio is hard enough. Focus on getting the big things right.

• If you can’t help yourself, limit yourself to a few speculative ideas a year. Two or three sounds about right.

• Keep the amount you wager small. No more than 1% or 2% of your portfolio.

• Earning 100% on a stock can be an emotional roller coaster. Earning 10,000% can lead to a lot of sleepless nights.

• Let’s say you do find a unicorn; as the dollar amount you have invested grows, you become much more sensitive to drawdowns.

• Just because you take big risks does not mean you’re entitled to big rewards.

Source: The Discipline of Value Investing

Michael Batnick is director of research at Ritholtz Wealth Management. This column first appeared on his blog, The Irrelevant Investor. His Twitter handle is @michaelbatnick.

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