By Mike Uzor Financial Analyst, Datatrust
By investing, you are putting your money on the job of working for you in expectation of a decent return. How much of good works the money you invest will be able to do for you depend on how you have deployed it and in what conditions it is set to work. You are the master and money the servant; it obeys your commands at all times – good or bad commands.
How well therefore you will succeed in the investment market in 2017 depends on how good are your investing decisions. In order to invest wisely this year, you need to avoid the common investing mistakes that have made people lose fortunes in the equities market. In the same market, fortunes are made and fortunes are lost every year. You can be on the side of winners.
You don’t invest at all, you exclude yourself from a readily available opportunity to build capacity for the future. Nothing ventured, nothing gained! By investing this year, you are taking a step forward to joining those who are buying the future upfront. The biggest mistake anyone can make is to fail to be part of those who will determine future values.
The wealthiest of the future will be people who are buying at today’s prices the values to be delivered tomorrow. Conversely, the poor of the future will be those waiting to buy future values at future prices. These will have no choices in a future in which prices will be significantly higher than they are today. Those who are looking for instant gratification will limit their financial capacity in the future. ‘If I had known’ is no excuse; it is a mistake!
Irrespective of the winds and the clouds of the economy as we see them today, we are commanded in Ecclesiastes 11: 4-6 to go ahead and sow this year. There can be no harvesting without sowing. Your corn of wheat must die in the ground for it to bring the much fruit you desire – John 12: 24.
Failure to manage investment risk is one of the key lessons from the last stock market crash. Most people tend to pursue high returns without adequate safeguards to mitigate the attaching risks. Risk and return go together, the higher the return expected, the higher will be the risk accompanying it. Focusing on the return and ignoring the risk leaves the investor without remedial actions to be taken if the risks occur.
Inability to identify and manage the various risks to which financial assets are exposed is one of the critical investment mistakes in the dicey markets to be expected this year. Your investments are, no doubt, exposed to varying doses of risks – economic, market, interest rate, exchange rate, inflation as well as specific. Foreign portfolio investors here, for instance, are exposed to considerable exchange rate risk, which is why they stage a run any time the value of the naira looks unsustainable.
Managing investment risk is clearly defining appropriate steps to be taken in the event of the risk occurrence and effectively taking those steps to defend the value of the investment. Many people tend to be more concerned about how much profit they want to make on their investments than defending the capital they already have. Sacrificing capital you already have for profit yet expected is a mistake investors need to avoid in 2017.
Investing without investigating is a road that leads to losses and therefore has to be avoided. Stock market investing is an information-driven endeavour. You will need to find out as much information as possible about the company you want to invest in, particularly where it is headed on the earnings track. You need to probe beyond what equity issuers tell you in their offer documents and the information that company officials willingly dish out.
You will be amassing a great deal of investment risk by investing in a company you don’t have a reasonable idea of what business it is into. The more discoveries you make about a company’s operations, the more you will modify your investment decision and the more you reduce your risk exposure. You can’t afford the risk of putting your money in a company you don’t know its future prospects. Your investment decision is as good as the quality of information you have. Corporate earnings prospects have dimmed generally and the ability to select the most promising companies will be the key determinant of success in investing this year.
Buying/selling in panic is the easiest way to buy a bad investment and to be shaken out of a good investment as well. A panicky market is driven by sentiments of what is feared or anticipated rather than value. If you have good information about a company and therefore an idea of its fair value in the market, you will be mistaken to pick it at a higher price because others are buying it in panic. It is a mistake to buy a good investment at a costly price because it will not offer you a good margin of safety.
Also, if you have entered a good stock at a fair value on the basis of reasonable information about the company, why should you be shaken out of it in panic selling? When the market returns from such temporary outbursts of sentiments, solid companies easily rebuild their values and bad investments stay down. Consequently, the good investments you have sold, you can only buy back at higher prices and the bad stock you picked in panic you can only sell at a loss.
Investing with short-term money is equal to shooting yourself on the leg that you need for a marathon race. Investment in the stock market yields returns on a long-term basis. Availability of long-term money is the primary consideration for investing in equities. You can’t do the long running the market requires with money needed to meet short-term commitments. Your investments aren’t likely to mature for sale by the time you will have to pull the money to meet the short-term commitments.
If you have made a good investment in a stock, you have need of patience to permit the market build value for you. It normally takes quite a while for a stock to make a large gain. Expecting the large gain with short-term money is a big mistake. If you want to enter the market or you are already in it, define exactly who you are: a short-term, speculative trader doing hit and run on good and bad stocks or an investor sitting patiently on value building equities.
Greedy expectations from investments lead to a loss of sense of value of the investment. Something has caused the share price to move up after you have invested. Whatever that strength is, is it still available to justify your expectations for a further rise? An extra-ordinary growth in profit may have induced the capital growth your stock has achieved for you. Whether the high growth is sustainable or not, it usually spurs a bullish run any time a big leap in earnings per share occurs.
The potentials for a spectacular share price advance do get exhausted and so your sure winner isn’t going to continue winning every time. Test your winner for ability to remain on the winning stream and a trader may leave before the market exhausts the short-term potentials. If a trader enters a winning stock without a potential exit point, it is a mistake because he will be expecting a historic event to build value in the future. It will not happen! Expecting a stock that won yesterday to keep winning without a new potential is greed to be avoided this year.
Putting all eggs in one basket is a major mistake in the equities market because you can’t get far with just one or two stocks in the basket. Diversification is the widely recommended approach to reducing investment risk. You may have invested in shares with profound information available at that point in time, yet your investment is subject to so many imponderables in the economy. Some investments are bound to perform below expectation while some might do better.
A diversified basket reduces the risk of underperformance by including stocks that stabilize portfolio value in a difficult market. Diversification isn’t in any way suggesting covering the waterfront. It is not a matter of numbers but of how the stocks in the basket are positioned to counter the downward risks of others and ultimately achieve the expected average return on investment.
You don’t know when to invest, you are bound to lose because even the blue chips have their seasons of buy and sell and growth stocks do lose their high growth momentum. When you discover a good stock, you need to target a good opportunity to buy it cheap – that is when it is under priced by the market. This creates a margin of safety for you, which easily places you in profit and builds a defensive margin of error if something goes wrong.
Most people tend to buy stocks when the price is moving up, not considering whether it is about to exhaust the short-term movement. Timing your entry into a stock is a far more important strategy to build profit than the average investor appears to appreciate. Studies have shown that making a right entry on a stock gives you a 50% chance of making a profit and a 20% chance of making a loss. It is a mistake to enter a stock when it is making a new price high because the potential for a loss in the short-term is high.
Dealing with a ‘deaf’ stockbroker in a dynamic market leaves you with a great risk of striking when the iron is cold. Before he acts, the opportunity you wanted to take advantage of has passed. The stockbroker plays a crucial role for an investor to make the right entry and exit on a stock. For this reason, he should be a stockbrokers that ‘hears’ your orders at once, understands what you want to accomplish and executes them promptly.
If your broker is hard of hearing and slack in acting on your orders, you will be making a mistake to continue to rely on him this year and expecting better results. If he has caused you to lose good opportunities before, don’t be mistaken, he isn’t going to change this year. Try a new stockbroker and let him know your reason for leaving the old one. That will be a warning signal for him that if he fails to satisfy you, you will most likely leave him as well. The Nigerian Stock Exchange has developed facilities for individual investors to buy and sell stocks directly.
A flight in penny stocks faces a high risk of a crash. Penny stocks are like roses growing on thorns: you may hit the jackpot and you may also lose everything. They are more or less a gamble; anything can happen. It takes only a few kobo movement to produce a large percentage gain as well as a big loss. If you have an investment basket dominated by penny stocks, you are taking a flight that has a high chance of crashing.
While penny stocks are comparatively low priced and sell at a small fraction of the prices of major equities, it is a mistake to consider them as cheap. Cheapness is relative when it comes to share investing. A stock is only cheap when it is underpriced and expensive when overpriced. A stock is therefore cheap if it has the potential to go up in price and expensive if it is likely to go down irrespective of the price tag. You think a stock that merits its low price is cheap, you are mistaken.
Investing forward and looking backward is very likely to end in a stumble and a fall. Investing is future dependent and no one can build a good future by relying on what happened in the past. The company may have doubled profit last year but what is it likely to do this year. Does the company have strength in the future – financial health, household product names, able sales force, a large distribution network, capable management and so on? Share prices are built by current and anticipated earnings, not how big was last year’s profit and dividend.
Whether or not your investment will do well is dependent on the company’s future performance. If you are investing in the future, you are betting with your money that the company is going to do well in the future. You need to convince yourself about the ability of the company to maintain or improve its earnings growth momentum. If you are making such a serious bet with what happened in the past, it is a mistake. You can’t really move forward while looking backwards.
Impatience with good investments prevents you from being around when the stock market will finally build wealth for those that are right with their investments. It is a great virtue to be patient with share investments but only when the investment is right. Many people who move out of good investments are usually those who do not understand the stock. They might have entered it because they expect the price to move up in the short-term. If it does not, they are not interested. If you are one of such people, the post crisis equities market is not for you.
In the pre-crisis period, even the stocks of closed down companies went up in prices. In the present market environment, even the best performing companies aren’t easily bulging up. It appears to be a market that tests the heart of investors – whether they know their stocks. Those who are sure of their investments need patience to get to the points of harvest. If you are sure that your company is on the high growth track and you are impatient with it, you are mistaken.
Investing in highly indebted companies will be a major mistake in the present high interest rate environment and depreciating local currency. High interest rates have undermined the ability of many companies to grow wealth for shareholders for many years now and the sustaining fall in the value of the naira is increasing the pain through exchange losses. Before you invest, you need to be pretty sure that your capital is going to work for you and not for lenders.
The impact of finance cost on the income statement is now very crucial and is worth giving a careful consideration before you invest. A high level of balance sheet borrowing registers its adverse impact on the bottom line by claiming a significant share of a company’s revenue. Highly indebted companies have continued to face considerable erosion of profit margins for the past several years, which could worsen this year. You can’t rightly invest in such companies this year and expect to earn a decent return.
Gambling in the name of investing is exposing your money to a high level of uncertainty of possible events and yet expecting the favourable outcome. If your investment has a 50-50 chance of winning or losing, you are gambling. Investing doesn’t reside in that realm of high risk exposure. If you do not take steps to reduce the chance of losing on your investment and improve that of winning this year, you are making a big mistake in a dicey market.
The low risk approach involves probing into the future prospects of companies and selecting those with sustainable earnings capacity. You need to convince yourself about how big and sustainable the future earnings of the company before you invest. The higher the prospects for delivering unending stream of incomes in the future, the lower your risk exposure on the company.
Investing with money you can’t afford to lose and still stand is equivalent to betting with everything – money, life and family in a market that is subject to innumerable, indeterminable forces. No matter how proficient you are in stock market investing, you are bound to pick up bad investments from time to time. If by picking one or two bad investments, you are ruined, this is a mistake – you have not yet learned the lessons of the last market crash.
The stock market is a high risk zone and you cannot safely enter it with all you have. When you send out your money into the stock market for a high return attack, you are like a military commander, who has dispatched soldiers to the battle front. Some may win and return, some may fall under cross fire and still all may be lost. If you send out everything without considering the chance that all may be lost, it is a big mistake.
Ignoring inflation is to ignore a major risk element in deciding where to invest in the first place. When prices rise, the value of an investment goes down and all investments that offer below inflation rate returns will wash away the real value of your capital. Is the value of your investment likely to grow ahead of inflation this year?
One of the main attractions of share investing is that it provides a hedge against inflation. Investing in the stock market has proved to be one effective way of preserving and increasing the real value of money. If the value of your capital isn’t likely to grow ahead of inflation this year, rising inflation arising from depreciating local currency is bound to penalize you.
Buying sympathy stocks isn’t going to draw sympathy for your dwindling capital value when they eventually begin to show their mediocre performance. Sympathy stocks are the laggards in every market segment, just next in consideration to the leaders in that segment. Because they trade at lower prices than the best equities in the segment, there is always the temptation to believe they will follow the impressive advance the leaders are exhibiting.
This is often quite deceptive because the market quickly remembers their poor fundamentals every time the bear shows up in the market. Just because the leading stocks have moved up in price does not offer a justification for sympathy stocks. They are likely to follow the leaders in sympathy for a rising market but they sympathize much more for a falling market. Expecting to win with mediocre stocks is a big investing mistake.
Averaging down on a bad investment is throwing good money after bad. The consideration for buying any stock is good earnings expectation or technical outlook. The expectation is that the stock will go up in price but if it begins to go down instead, it is an indication that the expected earnings quality may no longer be realizable. This calls for a reassessment of the company’s earnings potential.
When the share price is declining due to deteriorating earnings, the strength for a price recovery is broken. Such a stock is set on a long downward journey. If you start average down on it, this is a mistake because there will be no end to it. Using your money to defend your mistake on a bad investment is another way of trying to hide the truth from yourself. Accept you have made a bad investment and then cut your loss and run.
Defending stocks instead of capital is trying to show that you are right when you might be wrong. Mistakes in equities selection are inevitable in stock market investing and this requires a plan of action to prevent the mistake from consuming your capital. The profit you are going to make isn’t more important than the capital you already have. You therefore need to draw a defensive sell line for each investment you make this year, setting the price point at which you must cut your loss and leave.
The defensive line is a downside target price for the stock, which allows some room for normal share price fluctuations in the short-term. How much accommodative room to allow depends on the relative strength of the stock’s performance and the state of the stock market generally. If the share price touches the sell line, no matter how much you love the stock, it is a sell. Your duty is to defend your capital and not stocks that are mere instruments for its growth.
Acting on buy/sell opinions rather than research-based findings and superior information can cost your good money. Buy and sell seasons come and go continually for individual stocks and for the market. Irrespective of the strength of fundamentals, every stock has alternating periods of buy and sell. A stock needs to pass a series of signals to be reasonably judged a buy or a sell. Without the confirming signals, a buy/sell tip is a mere opinion and it is a mistake to bet with your money on it.
For instance, the key test for a buy is whether a company is growing ahead of its five-year average earnings per share. The earnings test serves as a screening tool to separate good stocks from the laggards. For a stock growing ahead of average, at every point of short-term correction, it is likely to bear a buy signal if the other indications are supportive.