In the stock market, there are many simple valuation techniques investors can use to gauge whether, or not, a company is a worthwhile investment. However those who choose solely to rely on historical figures disregard an equally important valuation metric, common sense.
As investors it's important we make investing decisions objectively, but it's perhaps more important we're confident in our decision making. If, for some reason, you're not completely comfortable holding a company then simply don't hold it.
Just make sure it's a rational decision to sell and not one made out of fear because your stock has slipped 5% or even 20% in price. Trust in your previous ability to make good investment decisions. The rest is just a matter of time.
The best investors
As history has shown us the best investors combine a mixture of both financial value and past experience to make savvy investment decisions. They remain patiently objective and don't get roped into buying companies currently experiencing a boom, nor do they let a drop in share price dictate their strategy.
Let's take a look at the below three companies and see how they would fair against a patient, rational and objective investment strategy.
National Australia Bank Ltd. (ASX: NAB) is somewhat of a serial underperformer when it comes to the big banks. Which could be one reason it trades on cheaper multiples. However it's still expensive. Although Australia has experienced both a housing and mining boom in recent times, thereby providing an excellent platform for NAB (our country's biggest business lender), we appear to be coming into a slower patch of economic growth but the bank has more expensive valuation metrics than ever before.
In addition would it be naïve to think increased competition from mortgage brokers and regional institutions like Bendigo and Adelaide Bank Limited (ASX: BEN) will impact margins? I think not. And with interest rates likely to rise in the next few years (likely to result in more bad debts), earnings will come under pressure. A patient and objective investor would adopt a wait-and-see approach with NAB shares at current prices.
Ten Network Holdings Limited (ASX: TEN) is also the ugly duckling in a tightly competitive industry. No doubt, it's been on many investors' watchlists as a potential turnaround story, but it is yet to show any signs of doing so. Although it claims to have a healthy balance sheet, the total number of shares outstanding has grown from 1.3 billion to 2.58 billion since 2011. Its business model is also coming under intense pressure with demand growing for internet based services like YouTube and Foxtel Presto. Its programming in recent years has also proven to be second rate to its peers Nine Entertainment Co Holdings Ltd (ASX: NEC) and Seven West Media Ltd (ASX: SWM). Common sense tells you it's a risky investment.
Qantas Airways Limited (ASX: QAN) recently suffered a pullback in share price following intense media and investor scrutiny over its huge profit loss and the government's response to it. In the tightly competitive airline industry, with more expensive services than its peers such as Virgin Australia Holdings Ltd (ASX: VAH), Qantas is not an investment for the faint-hearted. Don't be fooled by low price to book ratios and a large market capitalisation.
Foolish takeaway
Applying a common sense approach in the stock market is more difficult than many investors think. We sometimes let our emotions cloud our view of what is and what isn't a golden opportunity. However applying strict valuation criteria with a little bit of patience is one way to navigate some of the potential hazards in the stock market.