Earlier this week I wrote about how new investors in the share market should avoid 'two egregious' investing mistakes that are surprisingly common amongst retail investors.
The mistakes were not diversifying and 'speculating' on get-rich-quick, penny ,or story stocks that often have no revenue let alone profit. Unfortunately a lot of these types of companies are more about separating inexperienced retail investors and their money, rather than offering ownership interests in high-quality and profitable businesses.
So assuming we're smart enough to understand the fundamentals of how capital markets operate, let's consider four common investing mistakes to avoid.
- Paying too much for fast-growing companies – this is an understandable mistake and can be tough to avoid, however, it's important to remember no business is a buy at any price, while returns are a direct function of price paid in any investment. For example businesses like Pro Medicus Limited (ASX: PME) or AfterPay Touch Group Ltd (ASX: APT) have vertiginous share price charts, but patient investors might get much cheaper entry points in the 12 months ahead..
- 'Bargain hunting'. A lot of new investors will look at historical share price charts, shares with low price-to-earnings ratios, and lists of 52-week lows for investment ideas. As it's a surprisingly common mistake to think that if a company has fallen from $10 per share to $5 per share it's only a matter of time before it returns to $10 per share. Whereas normally the reverse is true in that losers tend to keep falling, while risers keep delivering. For example companies recently printing 52-week lows include Retail Food Group Limited (ASX: RFG) and iSentia Group Ltd (ASX: GSW), unfortunately though debt has become a problem for them on the back of bad operational performance. Once a business has too much debt its share price can end up in permanent reverse.
- Buying non-investment grade companies – it's crucial to be picky about where you choose to allocate your funds. In fact it never ceases to amaze how many average companies Australian retail investors are happy to buy. Signs that a company is average or non-investment grade include; falling profits, limited track record, weak balance sheet (too much debt), changing management, no management alignment, no competitive advantage, no pricing power, missed forecasts, unclear reporting / accounting structures, constantly backing out costs when reporting, or no consistent profit growth. Remember a company's share price will always follow dividends and profits higher or lower over the medium term and longer.
- Selling winners – the big returns are made via compounding. Don't listen to those who advise "it's time to take profits" on strongly appreciating stocks – this is an amateur investing mistake. After all if a company keeps performing well there's nothing to stop its stock rising indefinitely, you just have to accept a few bumps on the road. Just take a look at the returns of REA Group Limited (ASX: REA) or Computershare Ltd (ASX: CPU) since listing, the latter is up over 16,000% as a public company. Manage risk if a single position balloons to say 15%-20% of your portfolio, but always let your winners run indefinitely. This principle coexists with a long-term investing philosophy that lets time and profit growth do the heavy lifting for your returns.
Avoiding these four investing mistakes will almost certainly boost your returns (a lot) and in my final article on the topic of investing mistakes to avoid, I'll cover off avoiding probably the costliest investing mistake you can make.
