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Want To Avoid Losing Money In Stocks? Do These 3 Things

Carl Gustav Jacob Jacobi is a German mathematician who was born in the early 19th century. He has a reputation as one of the finest mathematicians the world has ever known. But just why would a math wizard appear in an investing article here?

Thing is, Jacobi has a phrase that’s oft-quoted by investing maestro Charlie Munger and that is, “Invert, always invert.” Jacobi believed that problems are best solved when inverted. I believe this applies to investing too.

So, instead of asking “What should I do to make money in stocks,” a better question could be “How should I avoid losing money when investing?”

To answer the latter question, below are three things we can do. While the list I have here is not exhaustive as a ‘how-to’ on minimising your odds of losing money while investing, it’s still a good place to start.

1. Avoid short-term stock market forecasts

It’s tempting to listen to the views of highly-paid and well-respected finance professionals on the stock market’s short-term future and then invest accordingly. But, it’s worth noting how horrible their collective track-records are.

Financial institutions (think banks and investment firms) on Wall Street, the Capital of finance in the U.S., have people who work as “market strategists.” These guys (and gals) are well-read, highly educated, very well-compensated – and very wrong at times.

One of their key jobs involves forecasting, at the start of the year, where the S&P 500 (one of the key stock market indexes in the U.S.) will be by the end of it. Earlier this year, my colleague Morgan Housel had looked at these strategists’ track records going back to 2000. He then plotted the results of each year’s average forecast into the chart seen below:

S&P 500 forecasts

Source: Birinyi Associates, S&P Capital IQ (Morgan Housel)

The chart shows that the forecasts were wildly different from the market’s actual performance in many of those years (the blue bars represent the average forecast gain while the red bars represent the market’s actual return). In fact, according to Morgan, “the strategists’ forecasts were off by an average of 14.7 percentage points per year.”

2. Be careful with highly-valued shares

Shares with expensive-looking valuation metrics are not always bad investments. But, it pays to at least be careful with a stock that is very highly-valued.

Near the end of May this year, Jason Holdings Limited (SGX: 5I3), a company that provides timber flooring services, was trading at S$0.64 and being valued at 330 times its trailing earnings and 9.4 times its book value.

At that time, the market – as represented by the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks the fundamentals of the market barometer, the Straits Times Index (SGX: ^STI) – had a price-to-earnings (PE) ratio of just 14.

Today, Jason Holdings’ shares are exchanging hands at S$0.073 each, some 88% lower than the price of S$0.64.

3. Pay close attention to companies with high-debt

Debt can be used in a smart manner by companies to create value for shareholders. But, debt can also be a source of big trouble, especially when companies start piling it on.

The late Walter Schloss, who is an investor with a great long-term track record, once wisely said: “I don’t like debt because it can really get a company into trouble.” It’s such a simple yet powerful statement.

Fishmeal producer China Fishery Group Ltd (SGX: B0Z) is a vivid example of the potential destructiveness of debt. As you can see in the chart below, the company has been heavily-leveraged (as alluded to by the high net-debt position) for many years:

China Fishery Group's Balance Sheet (2)

Source: S&P Capital IQ

Last week, Bloomberg revealed that one of China Fishery’s lenders, the bank HSBC, had taken legal action against the company because of debt-related issues. China Fishery has since appointed provisional liquidators to help deal with the problem and suspended the trading of its shares. The company’s stock has fallen by 73% over the past year.

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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 doesn't own shares in any company mentioned.