These five misconceptions can get investors into big trouble
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Confusing a good company with a good stock
We have mixed views on this one. We believe that a good or great company, in the long term, is going to get you solid investment returns, eventually, even if you pay a lot for that company. Great companies have a beautiful way of growing into their valuations. However, in the short term, things are very different. If you pay too much for a good company, you might not make any money from that stock for a very long time. Conversely, you might find you are able to buy a lousy company very cheaply. Again, in the short term, you might make way more money from a bad company priced cheaply than a good company priced expensively. In the market bounce since March, this has been exemplified. Some investors have made small fortunes buying stocks of highly indebted companies that might not even make it to the end of the COVID crisis. But in the short term, they are making bank from buying bad companies at highly discounted valuations.
Restricting your investment criteria
This one may also apply more to fund managers. Most individual investors can do whatever they wish. But fund managers often have restrictions, be it market cap limits, sector, geography, investment style, and so on. Any restriction on investment criteria will, of course, reduce the size of your investable universe and potential returns. If you are a value manager right now, you know all about this, as growth stocks are running hard, leaving your value fund in the dust. We like mid-cap growth companies, but that doesn’t mean we ignore other possible investments. It is better to look at everything — with no restrictions — and then decide. This is going to take more time and effort, naturally, but your investment returns will be better for it.
Peter Hodson, CFA, is Founder and Head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals.