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Scary Tales From Investing Masters

BOO!!! Halloween is upon us, and individual investors may be looking to creep out of October, the month which is the “horror house” of the biggest market crashes in history.

The cautionary tales and thoughts below are done in the spirit (pun intended) of Halloween. And, the spooky tales are narrated by some of the best folks that the investing world has ever seen.

Spooky Tale No.1 – Peter Lynch: “It’s only $3 per share, what can I lose?”

Peter Lynch became the head of the US-based Fidelity Magellan fund in 1977, and from there, he managed to deliver compounded annual returns of 29%for his clients over the next 13 years. In his book One Up on Wall Street, the investing master shared this snippet about “dangerous things people say about share prices”:

“I put in twenty years in the business before it dawned on me that whether a stock costs $50 a share or $1 a share, if it goes to zero you will lose everything. If it goes to 50 cents a share, the results are slightly different. The investor who bought in at $50 a share loses 99 percent of his investment, and the investor who bought in at $3 loses 83 percent, but what’s the consolation in that?”

The initial share price should not be the main consideration of the Foolish investor. Take the following example I had shared previously. Back in mid-December 2004, the share price of classifieds publisher Global Yellow Pages Limited (SGX:Y07) was a low S$1.71 while the share price of pan Asian retailer Dairy Farm International Holdings Ltd (SGX:D01) was also a tiny US$2.52.

Fast forward 10 years later to 8 October 2014, and we will find that shares of Dairy Farm had handily beaten the market with a 278% return while Global Yellow Pages faded like a nightmare. The reason? From mid-Dec 2004 to 8 Oct 2014, Dairy Farm’s earnings had gone up almost 100% while Global Yellow Pages’ earnings had sunk by about 90%.

The bottom line is this: The underlying business behind the ticker matters more than the share price itself. So, don’t be easily impressed by a well-made bed (a low share price), as there may be spooky monsters lurking under it (a lousy business).

Spooky Tale No.2 – Philip Fisher on the high costs of having an ego

The late Philip Fisher, who had a profound impact on billionaire investor Warren Buffett, had this to say in his book Common Stocks and Uncommon Profits:

“There is a complicating factor that makes the handling of investment mistakes more difficult. This is the ego in each of us. None of us likes to admit to himself that he has been wrong. If we have made a mistake in buying a stock but can sell the stock at a small profit, we have somehow lost any sense of having been foolish.

On the other hand, if we sell at a small loss we are quite unhappy about the whole matter. This reaction, while completely natural and normal, is probably one of the most dangerous in which we can indulge ourselves in the entire investment process.

More money has probably been lost by investors holding a stock they really did not want until they could ‘at least come out even’ than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous”

One possible cause of this phenomenon could be the psychological effect of “loss aversion”. In this instance, individual investors may be unwilling to let go of shares which were purchased at higher prices and at the same time, fail to acknowledge that the company’s business model may have undergone permanent damage.

The inability to admit a personal error can be akin to letting undead zombie-shares fester in your portfolio when the capital – as Fisher would argue – could have been put to better use elsewhere.

Foolish Spooky takeaway

One way to get better at investing would be to commit less ghastly errors. Learning from spooky tales like the above from investing masters who have been there and done that might just help us become better without us having to experience scary walks alone on our investing journey

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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 contributor Chin Hui Leong doesn’t own shares in any companies mentioned.