A wayward person who likes to “knock about”
From time to time, investors end up focusing on the wrong thing. Truthfully, it’s easy to see why this happens. The constant buzz and need for “activity” in markets is enough to shift the unsuspecting investor’s focus from what’s really important: the company.
Investing legend Peter Lynch says it best: “Behind every stock is a company. Find out what it’s doing” Like many other elements of the investing world, the things that sound the simplest to apply are sometimes the most difficult. It’s fairly obvious to understand the logic behind Lynch’s words. Too often investors fixate on a company’s share price without figuring out what’s happening with the company itself – effectively akin to judging a book by its cover.
This approach is inherently flawed simply because several factors beyond an investor’s control (or study), at any one time, could be driving a company’s share price – the least of which could actually be what’s taking place with the company. For example, if a company’s stock price jumps by 25 per cent in one day, does it mean that the company is now 25 per cent “better”? Highly unlikely.
However, if the company has, over time, demonstrated solid growth in sales, market share and earnings (known as its “fundamentals”), one would expect that eventually (though no one can predict a date) it’s performance would be reflected in its share price.
As Warren Buffet says, in the short term, the stock market is a “voting machine”, but in the long term, it is a “weighing machine”- weighing the actual performance of the company itself. Thus, the wise investor who pays attention to the company itself, is likely to benefit as the stock price moves to reflect improved performance.
Investors who judge stocks by their prices also do themselves a disservice in another way – they falsely presume that a stock with a small dollar price is cheap, while another with a heftier price is expensive.
This misconceived notion can lead investors down the wrong path and into some bad decisions for their money.
The cheapest stocks also tend to be the riskiest. For example, that stock that just went from $40 to $4 might end up at zero.
And a stock that goes from $10 to $20 might double again to $40.
Only when an investor is armed with company-specific data will he have a sense of what’s likely to happen next, and as such, how he should calibrate his decision making.
That said, there are several metrics available to investors to understand exactly where a company stands performance-wise.
This is where the rubber meets the road. Understanding companies takes time, diligence and effort. In the words of investing legend Charlie Munger, “investing is simple, but it’s not easy.”
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