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Listen to the full episode on iTunes (and please leave a rating to help the podcast reach more people): E31: Investor Beginner Errors You Really Want to Avoid
Below you can find the top 6 investor beginner errors you really want to avoid:
Celebrate High Valuations:
- You have your stock portfolio and the valuations are going up.
- Why are you celebrating? You are still not done buying.
- You still have an income and you’re still an investor.
- You really should be celebrating low valuations so that you can buy more shares for your money.
- You want to be able to buy things at a low valuation.
- Given that there’s a bright future for the company, buying at a low valuation means you will get a higher return.
- Thus, a low valuation means a high margin of safety.
Listen to Company Managers and Brokers:
- They’re not your friends.
- Brokers: They’re in the business of sales and making commissions.
- Managers: They’re in the business of making the company as expensive as possible.
- They don’t benefit from having you invest in great shares at a low valuation and high margin of safety.
- When brokers and managers discuss PE (price/earnings ratio of the year), this number is not representative of the long term cash flows of the company.
- It only shows one year’s performance in isolation.
- If the PE of next year is 10, it means you need 10 of those years to make your money back. This is why people like to use PE.
- This number is intuitive to understand but it doesn’t explain the years after that.
- This particular year could be an extraordinary year for a product’s life cycle or the other way around they could have incurred exceptionally high costs that year.
- The Schiller PE is much more accurate because it takes the last 10 years’ PE and adjusts for inflation. This cancels out the product life cycles and is much more accurate.
Scream in joy when one strategic investor buys from another strategic investor:
- Example: Warren Buffett buys a large steak from another key investor.
- Most people focus on Warren Buffett, the buyer because he ends up with the shares.
- How about the other key investor? He has been on the board for years and he’s selling his shares. The seller likely knows more about the company since he’s on the inside.
- Therefore, you should always try to look at this purchase from both the buyer’s and seller’s side.
Using the present tense when talking about the stock market:
- When people say “the market is going up” it’s wrong. The right thing to say is “the market was going up”.
- We can never know for sure where the market is going. All we have is past data and our own (hopefully) rational assessment of that data.
- The market moves randomly and it reflects reality which is inherently random.
- There are short term trends but you never really know when these trends break.
You think a positive story is all a stock needs:
- The narrative can change at any time but the facts stay the same.
- Momentum investor: You can try to get on any trend that latches on right now and then sell to a bigger fool when that trend turns.
- Value investor: You buy stocks that are priced lower than their intrinsic value.
- In other words, momentum investing is based on a narrative that can change at any time, while being a value investor is based mostly on facts.
- Being a value investor is a more rational long-term investment strategy because you never truly know when the narrative of momentum stocks turn. However, being a value investor requires more skill and real expertise.
- Example of value investing using Martin Sandquist: He said there’s no inherent value in bitcoin during the peak of bitcoin where the price had just increased 2000% in a year, therefore he wouldn’t put any significant percentage of his wealth into bitcoin. He turned out to be right. Shortly after this statement, the bitcoin price stopped increasing.
You think that you’re a long term fundamental investor and that the fundamentals of trading don’t apply to you:
- More than likely you will sell at the worst possible time and buy at the worst possible time.
- For example, when markets are falling you will keep telling yourself that you will hold onto your shares because eventually the price will go up. But once you suffer a loss of 5-7% you start doubting yourself and sell your shares. Then people buy the same shares as you at a low price and soon the markets go up.
- Example 2: When markets go up and you see everyone and their neighbor getting rich (like with bitcoin) you start buying stocks out of greed but then markets stop increasing.
- To make long term financial gains the goal should be to become a long term investor. Avoid herd mentality. Instead, make your own rational assessment of the share you’re considering to buy.
- A great way to become a more long-term oriented investor is to study the history of the financial markets. By studying the history, you will see that it often repeats itself. Short term investors (most people) keep losing a lot of money because of herd mentality (following trends) and greed. Most people neglect the study of the history of the financial markets and end up losing money. These mistakes keep repeating themselves every 10-20 years.
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* Why decision making and risk management? Because better decisions equal better finances, better relationships and an overall better life.
* Decisions are the foundation of everything you do and the outcome you eventually get.
Here’s a good reason not to invest in the markets: There are hundreds, maybe thousands, of guys like Syding and Sandquist making money there. They make it from losing investors, because the stock market is very nearly a zero-sum game. A lot of their gain comes from those who are investing other peoples’ money (pension funds, investment banks) and so don’t mind losing, but some also comes from amateurs who think they can outsmart the pros.
Having said that: I think PE is a dubious metric. It’s too easy for a company to manipulate its reported earnings with creative accounting or short-term measures leading to long-term losses. Looking at ten year old data doesn’t necessarily make it better, unless the business is exceptionally stable.