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Published on the sundaycircle.com
People perceive stocks as risky because share prices are volatile. The real risk however lies within you – your greed is your worst enemy!
Stocks are sexy because they present you an opportunity to gamble your way to richness. The problem with vice is that you probably will not notice that you are actually gambling rather than investing. Go through the list below and adjust your investment strategy if you fail from at least one item.
1. You will never beat Wall Street – so don’t try
Even if you follow the market all day – every day, you will never manage to beat Wall Street investment bankers at their job. They have the skills, knowledge and access to resources which you do not have. So do not try to be clever.
The good news is that Wall Street cannot beat you either because investment bankers focus on the short term. Hedge Fund managers and traders are primarily concerned with earning their bonus even if it means selling shares in a strong business or buying overvalued shares. Mutual Fund managers typically focus on increasing the size of the fund because their fees depend on that. Even though they focus on profitability in their advertising, maximising return comes secondary.
2. Buy a stock as if you were buying your own house
Surely, buying your house involved lots of dedication and time. You must have seen many properties before you decided to take the plunge. More importantly you made sure that you were not overpaying for the property you were buying.
Same applies to investments. Buying shares by looking at share price history is crazy as much as buying a house from a magazine. You need to analyse the financial health of the company and its growth prospects. In the same way you compare several houses to pick the right one, compare the company you like to its peers.
Assessing a company is not rocket science. Most of us are equipped with basic investing skills. Your common sense was an excellent guide when you were looking for you house, or car or TV set. Apply a common sense approach towards investments and you will be fine.
If you want to learn on how to assess financial performance, we highly recommend you to read “The Intelligent Investor” written by Benjamin Graham. To get you started, we’ve prepared a short presentation (www.blackdigits.com.mt/presentation) which summarises the idea of the book.
3. Buy strong companies and stick to them
Do not be overwhelmed by share price volatility. Markets are erratic and follow a herd-like instinct.
If you owned a business and sales are down this year, would you dump your business? I hope your answer is no because a one-off event does not make your business less valuable in the long term.
The same applies to investing in shares. If you invest in strong companies with excellent brand loyalties, do not be panic if share prices go down. Try to pick companies that enjoy strong brand loyalty and do not have much competition. Companies which have paid a dividend for many years also tend to be less volatile.
4. Analyse the company
If it took you months to buy your house, why do you decide to buy a stock in a matter of minutes? Evaluate the risks and opportunities of the company and also the industries within which it operates. Avoid companies saddled with debt and make sure you understand which geographic areas the company gets its revenues from.
You want to buy shares in a profitable business. Why would want to buy shares in a company that is generating a return on equity that is lower than what a government bond pays? You may be surprised, but many listed companies earn meagre returns.
Assess how expensive the stock is in relation to the earnings the company is generating by looking at the earnings yield. If you want to buy a property to rent out you would probably want to earn approximately 5% of the purchase price. Keep this benchmark in mind when looking at the earnings yield. This ratio is simply the earnings per share expressed as a percentage of share price.
Morningstar and Google Finance will provide you with most of this data on foreign stocks. Not much data was available on the local market so we launched this financial website dedicated to the Maltese listed market. The website is interactive and allows you to discuss your views. This is important because you will never see the whole picture by yourself. We received EU funding for this platform and access is entirely free.
Ever bet big on one event only at one point in your life? Well, we did on a few occasions and we regret it. You can be sure you will also be sorry if you bet on a few stocks. Generally, a well-diversified portfolio includes around 30 stocks exposed to several industries and markets.
Diversification will not come natural to you because it goes against your gambling instinct. Perhaps it is easier to think of diversification as an opportunity rather than a necessary evil. Diversification increases overall profitability because you are more likely to hit gold if you are vested in a wide range of instruments.
Diversification also means adding asset classes other than shares or bonds to your portfolio. For example, rental property is a great investment because it pays a constant source of income and is a great hedge against inflation.
6. Be patient
In the same way you threaded carefully (hopefully!) when the property prices were too high, you must also pay attention when stocks have rallied for a long time. Markets cannot rally for ever and the larger the bubble, the bigger the correction will be.
Use market panics in your favour. You can make good bargains by buying strong companies after financial markets melt down or bad news hit the wires.
7. Markets are not rational
People are greedy and not rational. Anyone who quotes the Efficient Market Hypothesis is a geek and does not understand one iota about human psychology. Bubbles have been with us since the 17th century and this is solid evidence that share prices do not always reflect the value of the underlying companies. So make sure you do not buy overvalued stocks.
Chris Grech and Calvin Bartolo are the creators of BlackDigits, a new local website providing an interactive financial knowledge and data centre aimed at facilitating investment decisions by allowing users to efficiently analyse and compare financial data.
ciajoe (7 years ago)
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