1 Thing We Should Really Stop Doing As Investors

Trying to find reasons for why the stock market has moved a certain way over a short time frame my seem a reasonable thing to do as an investor. But, it’s one thing we should seriously consider to stop doing as it can be really harmful.

I was reminded of market participants’ tendency to ascribe reasons for daily price movements when I read a Business Times article titled “China bounce, short-covering lift STI” that was published earlier today. In it, journalist R Sivanithy wrote:

“Either China’s reversal played a big part in triggering Tuesday’s rebound or investors were betting that Greece exiting the eurozone will be no big deal. Or equally likely was that trading programs were indulging in large doses of short-covering in anticipation of the same on Wall Street on Tuesday.

Whatever the case, a large bounce in the three banks and Singtel proved instrumental in pushing the Straits Times Index (SGX: ^STI) up 37.15 points to 3,317.33, thus recovering almost all the 41 points lost on Monday.”

So, a number of different reasons were offered to try and make sense of just why the Straits Times Index, Singapore’s market barometer, had moved the way it did on Tuesday. Why can this be potentially damaging to how we invest? In a recent blog post, investment manager Ben Carlson writes:

“When you’re constantly looking for a catalyst to explain every single move in the markets you start to see signals and correlations that just don’t exist. Most of the time we won’t know exactly why the markets moved a certain way until much later. Sometimes even with the benefit of perfect hindsight, investors still can’t agree on the specifics of the cause and effect.”

Put another way, if we can’t even find causes for huge events on hindsight, what hope might there be for us to determine every cause-and-effect there is for mundane everyday movements? If we find something which we think is there but really isn’t, then things can get dangerous as we might end up investing in a manner that’s totally unprofitable.

This raises the question: If we can’t explain how the markets move over the short-term, how then can we invest?

For this, we can turn to something the legendary investor Peter Lynch said. Lynch’s famous for his 13-year tenure leading the U.S.-based Fidelity Magellan Fund from 1977 to 1990; over that period, he clocked annualised returns of 29% (a 29% annual return turns $1,000 into $27,000 over 13 years!). In 1994, Lynch gave an investing speech and said this:

“I’m trying to convince people there is a method. There are reasons for stocks to go up. This is very magic: it’s a very magic number, easy to remember. Coca-cola is earning 30 times per share what they did 32 years ago; the stock has gone up 30 fold. Bethlehem Steel is earning less than they did 30 years ago – the stock is half its price 30 years ago.

Stocks are not lottery tickets. There’s a company behind every stock – if the company does well, the stock does well. It’s not that complicated.”

Over the short-term, all kinds of random events can push and shove stock prices all over the place. But over the long-term, there’s one very strong influencing-factor which shines through: How well the stock’s business does.

From the start of 2005 to today, vehicle inspection outfit Vicom Limited (SGX: V01) has made a daily loss/gain of 2% or more in 219 trading days, representing 8.2% of the time. Are these movements important when placed in the context of Vicom having gained 547% to S$6.21 today since the start of 2005 largely as a result of consistent and material growth in its profits and cashflows over the years (see chart below)?

Vicom's net income and free cash flow growth

Source: S&P Capital IQ

In an echo of Lynch’s words I shared earlier, Buffett once quipped that, “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.” Focus on what really matters: The long-term performance of a share’s business. Everything else is just noise.

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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 writer Chong Ser Jing owns shares in Vicom.