During my series – investing mistakes, I will cover a range of mistakes that anyone from a beginner to seasoned investor may make. Where I can, I will provide real life examples of such mistakes (often at my own expense) so you can avoid them.
I’ll begin with the top three mistakes for beginners.
1. Buying because it’s busy.
One of the worst investing stories I ever heard was from a work colleague.
He told me that he had recently bought shares in HMV group. Why? – Because he went to buy a few things from their Swansea store and it was really busy. It’s really important to remember that busy stores don’t equal profits and they certainly don’t equal financial stability.
Companies with busy stores could have poor margins due to pricing pressures, high levels of debt or even be on the verge of bankruptcy, as was HMV. Whilst in 2011 HMV stores may well have been busy it has massive debt and had to close 60 stores in order to reduce its debt pile. It later sold Waterstones for £53mn to try and further manage its debt pile. By 2013 administrators had been called in to try and save the ailing busnes.
ALWAYS check a company’s fundamentals before buying and don’t get sucked into hype.
This seems obvious to many but unfortunately this rationale for buying stocks is often quoted by many of my colleagues and friends.
2. Buying based on future earnings projections.
I have to admit, this is one mistake that I myself have made. If you take the time to look at my portfolio page you will see that I have a position in Whitbread. My rationale for initiating this position was, in reflection, considerably flawed.
Why did I buy Whitbread? I had just received a tax rebate and had some cash I seriously wanted to invest. Having scoured my watchlist I took a closer look at Whitbread and got suckered in by the future earning projections that analysts were making for the company. I saw consensus EPS of 3.06 for 2018 and then calculated the forward p/e ratio to 16 based on the £50 per share price tag.
I plunged into the shares recklessly happy with the ‘value’ I was getting for these notoriously expensive shares in full confidence that EPS would indeed grow. In fact I was buying in at an expensive p/e ratio of over 21 and was essentially ‘betting’ that the company would perform,
Needless to say, projections don’t equate to earnings – something clearly pointed out by Benjamin Graham in his book, The intelligent investor. A few downwards revisions later and my shares are worth closer to £40 each. Although the dividend investor inside me is quick to emphasise that a stock’s price doesn’t affect the income stream I get from it the value investor inside me is quick to point out that I significantly overpaid for the stock.
Although I’m still confident owning the shares, it is abundantly clear that I paid over the odds for my stake. I paid around 21 p/e which was a much more expensive multiple than its historic average of around 16.
3. Buying because ‘you think’.
Another mistake that’s often made is purchasing a stock because you own a crystal ball. I have too many friends who have bought shares in companies such as Tesla and countless green energy shares because ‘that’s the future’.. right?
Although it may be true that green energy will eventually replace fossil fuels that doesn’t mean that the shares on offer in that sector are worth the high p/e multiples that some sport. Always be careful before buying a share in any sector and don’t just buy a share because it’s in a sector/niche that you think will be successful – there may be better peers.
Make sure your rationale is secure before purchasing a stock and don’t rush in because of your preconceptions. Always do your homework and don’t think you ‘know’ anything because of a few headlines you read in a newspaper or from conversations with your friends.