Today’s topic is investment statements. Now, we are not talking about investment policy statements, where an investor outlines their goals and objectives for a portfolio. Those statements are extremely important (even though most investors don’t even have one), but we are instead talking today about statements investors like to make, and how they perhaps lead to the wrong decisions within their portfolios. We will try to offer some better alternatives to these commonly heard investor refrains.
‘I’ll sell that stock when I break-even’
Let’s be very clear on this. “Breaking even” is not, and should never be, an investment strategy. The goal of investments is to make money, not get back the same amount of money. But we hear this refrain almost daily. If you have ever said this about your stocks, you should change this investment statement — right now — to: “I must have picked the wrong stock, it didn’t work out, so it is time to sell this loser and buy something better.”
‘That stock is too expensive’
No. No. No. Many investors will avoid stocks on valuation. It is never a good idea, of course, to buy blindly, but one always needs to discover why a company has a high valuation. Maybe it has super-fast growth, maybe it has a wide moat, maybe it has a very high return on equity. You need to find out. Don’t dismiss a company on valuation alone. Certainly, the buyers of the ‘expensive’ stock today are not buying with the expectation to lose money. Find out why they believe in the company, what do they see? If you find yourself worried about valuation, change this investment statement to: “What are today’s buyers seeing that I don’t?”
‘That stock is so cheap it has to go up’
This of course is a contra-indicator to the above. Investors see stocks at valuations of three- or four-times’ price-to-earnings, and start to salivate. ‘It’s so cheap it can’t go down any further’, they say. But yeah, it can. Investors average down and buy more of loser stocks all the time, thinking if they liked a stock at $20 they have to love it at $10. We spin this around, though: If you were wrong at $20 it by no means makes you right at $10. Check the company’s debt, growth (or lack thereof), competitive positioning, cash flow, insider selling and everything else you can. Find out why some investors don’t want it at $10 when you thought it was great at twice the price. In our experience, it is almost always better not to average down on a losing position. Change your statement here to: “That stock is so cheap, maybe there is something wrong with it. I better find out.”
‘A dividend cut is already priced in’
We have heard this one from investors a lot this year. Many stocks, after the March sell-off, were yielding eight per cent, nine per cent or more. Investors assumed, that since yields were so high, that other investors were simply assuming that a dividend cut was inevitable. They figured that, since everyone was expecting a dividend cut, the stock might not decline, or might actually go up, when the company finally decides to cut the dividend. But, oh, how wrong they might have been. Many companies of course have had to cut dividends, and sometimes investors still seemed shocked by the cut and stocks declined. Of course, the bounce following the March lows has helped offset some of the dividend pain, but as investors see lower income from their securities they may be tempted to keep selling. Change this statement to: “Despite a high yield signalling lots of risk, investors can still dump a stock that cuts its dividend.”
‘Bank stocks (or any sector) will always be good investments’
This is a bit like whistling through a graveyard, where investors convince themselves to hold sectors during market declines. We have mixed views on this one. On the one hand, time is a very good healer for stock market ills. Bank stocks, as an example, have generally been solid long-term historical performers. But sectors can still go out of favour for years, and there is an opportunity cost to holding lots of stocks in a weak sector. Other than dividends, few investors have made any money at all on bank stocks in the past few years. We think some exposure is certainly warranted, as valuations are attractive, but do you really need to match the TSX Index exposure in banks, which is currently 30 per cent, when bank stocks are not doing anything, while technology stocks (nine per cent index weighting) are ripping? Sectors and stocks do not care if you own them. Nothing needs to go higher. Change this statement to: “I have no idea which sector is going to do well next year, so maybe I should have diversified exposure to all sectors.”
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.