Story, Numbers, Expectations. An Intro to Stock Picking: Part 3
One more thing
Remember what we’ve learned: Stocks Follow Earnings.
There is one more very important thing: Stocks Follow “The Market”.
Most of the time, the overall market will be moving your stock as much as anything else. When the market is up, you will be up. When the market is down, your stock will be down. Even if nothing changes with your company, when the overall stock market moves, so does your stock.
From day to day it can be difficult to notice any difference between your stock and the stock market as a whole. Over time, you begin to see the returns diverge between “stocks” and the “stock market.”
It can be quite frustrating if you did everything right when it comes to selecting the right company. You may have found the best company ever at the best price ever only to find yourself losing money on the wrong side of a market-wide sell-off.
That sell-off may have zero impact on your stock’s earnings or the value people will eventually put on those earnings over the long-term. That doesn’t matter. Risk is risk when the bears have the ball. Your stock is probably going down with everyone else’s that day, week, month or year.
You might as well have your expectations set ahead of time that times like this are not just possible, but probable. It will keep you from freaking out at the wrong time.
If you’re invested, it isn’t much fun when it’s happening, but a clear head and a long-term perspective can turn these events into bigtime money makers. If you can, try to take advantage of down markets because you can buy stocks “on sale.”
The stock chart is an incredibly useful tool to help give perspective on a stock’s price. Reading left to right, stock charts graph the historical price movement of a stock, giving you quite a bit of information in one picture. Most of us are visual learners on at least some level. Looking at a chart can help us better remember historical performance.
Look at where the stock has been lately. Where was it priced six, 12, 24 or more months ago? Are you buying a $20 stock that was $10 six months ago? Are you buying a stock that just doubled or tripled in value in the last six months? That might influence your expectations for how volatile the next six months might be. If the stock just had a big run, there should be expectations that you could see that price come down without anything changing in the story.
Imagine buying 100 shares at various points on the chart, and ask how much money you would have at that time? What would you do in each of those different scenarios?
If I bought 100 shares of The Stucco Bathtub Company at $10 per share and watched it go to $5 per share, that means my $1,000 just turned into $500. Could I live with that? What if my $10,000 turned to $5,000?
The rate of return was the same in each of those examples, but one hurt quite a bit more than the other.
If the price is lower, see if you can figure out why. If it’s a good company with a business you believe in, you may want to take advantage of the lower price to buy shares. Just make sure the story is still intact if the stock is down.
Expectations can have enormous influence over our behavior regarding when we buy and sell stocks. If we expect our stock to drop, how can we be surprised if it happens? If we know we need to focus on long-term performance, we should probably focus on long-term performance.
We want to be in a disciplined frame of mind to prevent making emotional decisions. Unlike charts and PE ratios, emotions are not helpful tools for investors.
Ground yourself in the story and numbers.
Expect the stock and the market to go down.
Don’t freak out, man. Keep your emotions in check.
Remember where we started, the stock picking process includes evaluating the story, numbers, and expectations for the business you are potentially purchasing.
What’s the story? What makes you want to own this business?
What are the numbers? How much money are they making?
What should our expectations be for the company and stock?
While we just scratched the surface of what it takes to be successful investing in stocks, hopefully you can see that many of the concepts are very simple in nature. You don’t need a lot of math IQ to be able to recognize a line out the door of a popular business, and sometimes that’s all it takes to recognize a GREAT stock pick.
Consider these quotes from Warren Buffett, aka The Oracle of Omaha. Buffett is one of the most successful investors in history and has repeatedly tried to tell the world that investing is much simpler than we make it:
“If you have to go through too much investigation, something is wrong.”
“You don’t need to be a rocket scientist to be a shrewd and successful investor.”
“There seems to be some perverse human characteristic that likes to make easy things difficult.”
“You should invest in a business that even a fool can run, because someday a fool will.”
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