“Survival of the fittest” is often mistaken as a phrase by Charles Darwin. It was Herbert Spencer who coined this phrase after Darwin’s “natural selection” from the Origin of Species. We are not going to discuss about Biology in this post. But the essence of “survival of the fittest” is adaptable to investments as it is about the animal kingdom.
Humans have no doubt emerged as the elite specie on Earth. The intelligence of human was the edge that our ancestors had and overtime, the gap between humans and animals began to widen exponentially. We continue to dominate the world and no human has complained about this privilege.
Let’s go back to the prehistorics where humans were not the humans we know. Imagine that you can choose to be any animal that you can be, what would you choose? Without knowing humans would survive and become the fittest, how many would have chosen to be a primate, where it may be tempting to be one of the fiercest animals like a shark or a lion?
Statistically, more animals become extinct than surviving over a long period of time (I do not have the figures but I hope you trust me on this one). Likewise, more companies go bust than thriving over a long period of time (likewise, no numbers to prove but I have strong conviction that this is true). There are two things to learn about this similarity.
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- It is easier to pick a company that goes bust eventually. The odds are against you.
- To win in the market, stay with the fittest.
Let’s move on to a lighter topic – soccer. I am a soccer fan and an English Premier League supporter. Every season, there will be 3 teams that relegate to Division 1 and in turn, the top 3 teams from Division 1 will promote to the Premier League. Overtime, the Premier League is about survival of the fittest. This ensures the best English teams are in the Premier League and fans can continue to enjoy tip-top football competitions.
Recently, FTSE, SGX and SPH reviewed the component stocks of Straits Times Index (STI). Five companies were added into the STI to replace the “weakest” five by market capitalisation. In addition, the frequency of review will be increased from semi-annually to quarterly. This means that there will be more chance of promotion and relegation in the STI Premier League. This is why Index Investing works – it embraces the principle of “survival of the fittest”. Do you know how to invest in the index? Read this.
Warren Buffett is one of the richest guys in the world. He only buys good businesses. He evaluates the ability of the companies to earn money and the durability of this profits in the future. He does not just buy cheap stocks because cheap stocks can stay cheap forever, or even disappear in the long run. He wants to hold only the best money-making stocks in the world. One of the wise quotes from Buffett which is apt in this context is, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” Fundamental analysis is about finding strong businesses that dominate the market and make lots of money. Fundamental analysis works if it is used to identify the
fittest most profitable companies.
In trading, we often heard the phrase, “cut your losses short and let your profits run”. The essence of this phrase is similar to the principle that we have been talking about since the start of this article. What goes up, continues to go up. This is due to the herd instinct of humans and in the short term, market movements have momentum. Technical analysis works if it is used to identify the
fittest strongest trending stocks.
Most retail investors lose money because their portfolio do not contain the fittest stocks. Are you guilty of this? Did you buy stocks because they are just cheap? Did you spend time evaluating the companies ability to earn money, and find out how they fare against their competitors? Did you trade stocks because they have not move up while the rest had? Do you keep “weeds” in your portfolio because you cannot bear to sell them and lose money?
Regardless if you are a Passive Investor, Stock Picker, or a Trader, your strategy and tactics must embrace the principle of “survival of the fittest” in order to profit from the market.