Do You Have This Common Misconception About Investing?

Credit: Simon Cunningham

I was out on Saturday with a couple of friends, when we struck up an interesting conversation on investing. As the conversation went on, a friend of mine commented, “Company X is trading at a 50% discount to its competitor. It’s a sure buy at this price.”

This got me thinking. How many times have I heard something like this? More importantly, is my friend’s line of thinking correct?

Let’s have a look at a short paragraph from the late Philip Fisher’s book, Common Stocks And Uncommon Profits, that can shed some light on the issue:

“Against this background, it can be seen why investors so frequently pass up stocks which would have brought them huge future gains, for ones where the gain is very much smaller.

By giving heavy emphasis to the “stock that hasn’t gone up yet” they are unconsciously subscribing to the delusion that all stocks go up about the same amount and that the one that has already risen a lot will not climb further, while the one that has not yet gone up has something “due” it. Nothing could be further from the truth.”

The paragraph above sums up a common misconception investors have about investing, and that is, a stock is a bad buy if it has gone up a lot and it is a good buy if it hasn’t.

The misconception is the outcome of investors focusing on stock prices. But focusing on prices isn’t the right thing to do. Just because a company with a flat or falling stock price has a competitor that has a rising stock price does not mean that the stock of the company must be due an increase in the future.

Here’s another couple of lines from Fisher’s book that shares what investors should be focusing on instead:

“The fact that a stock has or has not risen in the last several years is of no significance whatsoever in determining whether it should be bought now. What does matter is whether enough improvement [in the business] has taken place or is likely to take place in the future to justify importantly higher prices than those now prevailing.”

So in summary, as investors, we should focus on the future business prospects of a company rather than its stock price in order to make good investment decisions.

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