1 Basic Investing Mistake That You Shouldn’t Make

In expert tennis, 80% of the points are won, while in amateur tennis, 80% are lost. The same is true for wrestling, chess, and investing: Beginners should focus on avoiding mistakes, experts on making great moves.”

—Erik Falkenstein

Swedish economist Erik Falkenstein makes a good point. For those of us who are just beginning to invest, we may want to think of reducing errors first.

His point became more apparent while I was chatting with some ex-colleagues who are new to investing.

It dawned on me that there were several basic misconceptions about investing that may be prevalent among new investors. I feel that most of these errors can be easily avoided if only people were made more aware. So, here’s one such mistake.

The Expensive Stock

“The stock price is $10, so expensive!”

One common mistake that is made is to assume that the stock price represents the value of the company. What’s dangerous is that the misconception may lead the new investor to look at stocks that are trading at “cheap prices,” or what’s otherwise known as penny stocks.

Penny stocks trade for really low prices, sometimes as low as a few cents per share. But, they can be dangerous due to reasons such as them having lousy underlying businesses.

It’s important to remember that a low stock price does not imply a cheap stock price. They are two vastly different things.

Let’s compare conglomerate Jardine Cycle & Carriage Ltd  (SGX: C07) and integrated resort operator Genting Singapore PLC  (SGX: G13). Yesterday, shares of Jardine C&C closed at $32.33. In contrast, Genting Singapore’s shares ended the trading session at $0.75.

At a share price of under a dollar, some may start to think that Genting Singapore is the “cheaper” one. But, when we compare the price-to-earnings (PE) ratio for each company, the story is quite different.

Yesterday, Jardine C&C had a trailing PE ratio of 12 while Genting Singapore traded at a hefty PE ratio of 50. At a PE of 12, we are essentially paying 12 times the annual profit of Jardine C&C. Said another way, it would take 12 years for us to earn back our capital assuming Jardine C&C’s profit remains unchanged in the years ahead; for Genting Singapore, it would be 50 years.

From a price-to-earnings view, Jardine C&C can thus be considered to be significantly cheaper than Genting Singapore.

Foolish take away

If you are starting to invest, understanding the difference between price and value may be where you want to start. Buying shares with low prices might not always work out.

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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.