The Key To Successful Investing

Everyone can exhale again. For one brief moment last week, many people held their breath as political uncertainty in the United Kingdom threatened other parts of the world.

But as it turned out, it didn’t. Equity markets rallied; currency markets regained their composure and bond markets breathed a sigh of relief. That was after Scotland decided to remain as part of the United Kingdom.

But things could have been very different. Yes it could. If just one in ten of those who voted to remain as part the Union had changed their minds, the United Kingdom could have unravelled before our eyes.

Little Britain

In fact, the decision hung in the balance until 30 of the 32 regions in Scotland had declared their intentions. That was how close Great Britain came to becoming Little Britain.

It is pointless to dwell over the rights and wrongs of separation now. The people of Scotland have decided the matter for themselves.

There are, however, some interesting similarities between the Scottish referendum and the things that regularly go on in stock markets.

On each trading day, investors and traders cast their “votes” for the companies they like. The also vote against those that they do not believe are worth investing in. They do so by buying and selling the underlying shares.

If there are more buyers than sellers, then the price of a share could rise. But if there are more sellers than buyers then the price of a stock could fall. That is how the stock market works. In the short term, as Benjamin Graham once reflected, the stock market is a voting machine.

Voting goes on

But Graham also pointed out that in the long term the stock market is a weighing machine. This is where the Scottish referendum and stock markets differ, markedly.

In the case of the Scotland vote, there was a decisive winner and a definitive loser, once the polls had closed. But in the case of the stock market, the prevailing price of a share is far from final.

Voting goes on constantly. So, traders are casting their votes on a continuous basis. When more traders feel confident and assured, stock markets could rise. But if they feel insecure and anxious shares could fall.

But the biggest mistake that investors can make is to confuse the price of a share with the story behind the business. Peter Lynch once noted: “If you are going to invest in a stock, you have to know the story”. Many don’t, though.

Some investors can buy shares on a whim, without fully understanding the story behind the stock. But behind every stock is a company.

So our role as investors is to find out as much about what the company actually does. If we don’t, then our chances of success are no better than playing poker without looking at our cards, as Peter Lynch once quipped.

Long-term winners

Peter Lynch made another observation, which is something that many of us tend to forget in times of market turmoil. He said: “Often, there is no correlation between the success of a company’s operation and the success of its stock over a few months or even a few years.

But he also remarked: “In the long term, there is a 100% correlation between the success of the company and the success of its stock.

Companies such as Dairy Farm Holdings (SGX: D01), Sembcorp Marine (SGX: S51) and Singapore Exchange (SGX: S68) have been standout blue chips over the last decade. They have delivered exceptional total returns to investors in the last ten years. But that is provided we avoided dipping in and out of the shares.

That is the key to successful investing.

Make or break

In the minds of some traders, it might be old-fashioned to follow the earnings of a company. But sooner or later it is the earnings that could make or break an investment. What the share price does in the short term is only a distraction.

I will leave you this week with a headline that caught my eye. The Business Times wrote: “After the FOMC and Scots vote, what next?

What next, indeed.

As they say, you can always find good reasons to sell your shares in every morning paper. The role of a newspaper is to write catchy headlines – it sells papers. Your role is as an investor is to stay invested in good shares and not get scared out of them.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.