It appears to me that most investors are often on the lookout for winners. But, that may be the wrong focus, especially for newer investors. Here’s economist Erik Falkenstein explaining:
“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.”
In keeping with the spirit of Falkenstein’s thinking, here are seven big blunders for investors to avoid.
1. Not realising how common volatility is
2. Mixing investing with economics
3. Anchoring on past stock prices
4. Assuming that blue chip stocks are safe
5. Think a stock is cheap based on superficial valuation metrics
If you were transported back in time to 10 March 2009 (the day Singapore’s stock market reached a bottom during the Great Financial Crisis of 2007-09) and saw Global Yellow Pages Limited (SGX: AWS) and Pacific Andes Resources Development Ltd (SGX: P11), you’d likely think that both shares were incredible bargains.
|Company||Price-to-book ratio: 10 Mar 2009|
|Global Yellow Pages||0.20|
|Pacific Andes Resouces||0.27|
Source: S&P Capital
As the table above shows, both companies had stunningly low price-to-book (PB) ratios on that date. But unfortunately, even as stocks in Singapore have rebounded strongly in general since then, both Global Yellow Pages and Pacific Andes have seen their shares basically collapse.
|Company||Stock Price change: 10 Mar 2009 to 4 Feb 2016|
|Global Yellow Pages||-92%|
|Pacific Andes Resouces||-85%|
Source: S&P Capital IQ (Pacific Andes has been suspended from trading since November 2015)
The reason why both companies had been such big losers should be clear when we look at their corporate performance. From 10 March 2009 to today, Global Yellow Pages had seen its profit shrink from S$0.976 per share to a loss of S$0.309; over the same period, Pacific Andes Resources’ profit had slipped from S$0.069 to S$0.013. Both stocks have turned in horrible business results.
Superficial valuation metrics can’t really tell us if a stock’s a bargain or not. Ultimately, it’s the business which matters.
6. Not investing due to fears that a big crash is just around the corner
My colleague Morgan Housel wrote recently (emphasis mine):
“The whole wisdom of black swans is that people underestimate their impact. But overestimating can be just as dangerous.
Accurately diagnosing a rare disease might not be an accomplishment if you made 100 dangerous false-positive diagnoses before it. And accurately predicting a financial crisis isn’t an accomplishment if you spent your whole career before it falsely predicting doom.
Even at the bottom of the Great Depression, stocks fell back to where they were in 1924, five years before the peak (adjusted for dividends and inflation). So anyone predicting doom five years too early would have been better off just living through the market crash of the 1930s rather than avoiding it.
As the saying goes, more money has been lost preparing for bear markets than in actual bear markets.”
The italicized portion of the quote from Morgan is really worth highlighting. At the start of 2006, shares of Vicom Limited (SGX: V01) and Dairy Farm International Holdings Ltd (SGX: D01) were trading at S$0.93 and S$3.62 apiece. As a reminder, 2006 was less than two years before the Great Financial Crisis started rearing its ugly head.
But guess where Vicom and Dairy Farm were trading at their lowest points during the financial crisis? The answer: S$1.40 for Vicom and S$3.92 for Dairy Farm. That’s right – during the pits of the crisis, both companies had share prices that were higher than just a few short years before.
7. Following big investors blindly
It may be a mistake to copy the moves of famous investors blindly. Just ask Morgan. Nearly nine years ago – during the Great Financial Crisis – Morgan had made his “worst investment” ever. Back then, Morgan saw that one of his favourite investors had started investing in a mortgage lender.
Without digging further into the company, Morgan simply followed in. Unfortunately, the company went bust, Morgan lost his investment and the big-name investor… earned a decent return. What?! How? Here’s Morgan explaining:
“As part of his investment, the guru I followed also controlled a large portion of the company’s debt and and preferred stock, purchased at special terms that effectively gave him control over its assets when it went out of business. The company’s stock also made up one-fifth the weighting in his portfolio as it did in mine. I lost everything. He made a decent investment.”
We may never be able to know what a famous investor’s true motives are for making any particular investment. And for that reason, it may pay to never follow anyone blindly into the stock market.
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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 and Dairy Farm International Holdings.