One of the biggest reasons that many investors underperform is that they follow strategies based on myths rather than doing their own research and using due diligence. While a plethora of studies exist showing what does and doesn’t work, there are a number of myths that continue to endure and avoiding them will definitely make a substantial difference in your profits over time.
In this 4 Part series we’ll take a look at some of the biggest myths and do our best to debunk them for you. Enjoy.
Myth #1: Excellent companies always have excellent stocks
While it wouldn’t be a stretch to believe that an excellent company would also have an excellent stock and make a great investment, the fact is that some companies look great on the outside but, on the inside, aren’t as sound as you might think. For example, they might have an excellent product and a CEO who’s quite charismatic, but that charisma hides the fact that they aren’t profitable and have a business model that goes through cash faster than they can generate it. There are of course excellent companies that, due to their success, also have stocks that have a very high valuation.
Your best plan of action when you hear about a company that’s doing well is to conduct your own thorough research before you buy any of their stock. See if they’re financially sound by checking their financials and profits. Check their stock’s valuation to make sure it’s not over or undervalued and always keep in mind that even a good company can be a bad investment.
Myth #2: Growth is better than Value
It’s certainly true that people will pay attention to a company that has strong revenues and earnings growth. If those companies happen to be in emerging industries or their products and services are innovative, the attention can be even more intense. Stories like these are positive and it’s easy to believe that a company’s soaring growth will also lead to a huge rise in their stock prices.
Long-term data however is completely contrary to this opinion. In the compendium of historical data on stock and bond performance, the Ibbotson SBBI Classic Yearbook, long-term data showed that value definitely beats growth. For example, a portfolio of large-cap growth stocks between 1928 and 1912 showed an annualized return of 8.8% while, during that same period of time, a large-cap value portfolio had a return of 11%.
While that difference might not seem significant, what you need to consider is that your brokerage account balance, in just 10 years, would be over 22% bigger if you were investing in value stocks instead of growth stocks. That gap would also become even larger as you keep investing.
The reason for this mystery is simple; higher expectations often lead to disappointment and expectations for growth stocks tend to be much higher than for value stocks. Even worse is that investors expect a company that’s doing well to keep doing well and, as its revenue rates and earnings growth continue, valuation rises as more and more investors purchase the stock.
Consequently, when the company reports their sales and earnings, and they don’t need the expectations of investors, their stock price will plunge no matter what the actual growth rate is, or how strong it is.
Have these first two myths opened up your eyes a bit? Hopefully they have because we’d like you to come back for the next 3 Parts in our series to find out more. In the meantime, keep doing your research and learning as much as you can about investing in stock market. The more you know, the less risky any purchases you make will be.