Common Stocks and Uncommon Profits
5 More Don’ts for Investors
(Part 1: Chapter 9)
A.Don’t overstress diversification:
Diversification is one of the most important principles in investing.
The author says that almost everyone who is involved in the stock markets considers diversification.
The problem is very few people consider over-diversification.
Don’t buy just for the sake of diversifying. Buying a company when you don't have sufficient knowledge about a company or the industry it operates in, is far more dangerous than not buying a company at all.
If you’re holding a company that is very volatile in nature, you will need to diversify.
The author provides some rules for diversification:
1.Don’t put more than 20% of your investment into 1 company.
2.Never put more than 5% of your investments in small-cap or high-risk companies.
Buying more stocks does not necessarily mean more diversification. For example, if you own 10 stocks, but 7 of your stocks are from the Pharma sector, there is little or no diversification in your portfolio.
B.Don’t be afraid of buying on a war scare:
According to the author, war tensions can lead to good buying opportunities. Investors sell off excessively when a situation of war arrives, which in turn, makes a lot of securities undervalued. This point is not relevant anymore because major wars haven’t happened in the past 2-3 decades.
C.Don’t forget your Gilbert and Sullivan:
In this chapter, the author says that we shouldn’t over-analyse things in the stock market. Just looking at the price of a stock before making a decision is not logical. This is because the price at which a stock was selling 4 years ago may have little or no linear relationship with what its price is today.
We should remember that a stock’s price isn’t based on its today’s earnings. It is based on its future earning capacity. No factor of a company should be looked at single-handedly, like the P/E ratio, volume of sales, etc. We need to look at the whole picture of the company and see whether it makes sense to buy that company at its current price.
For example, the P/E ratio shows the current earnings of a company divided by its today’s price.
If a company’s major consumer canceled the contract, the majority of its sales would plummet. A person who just looked at the P/E ratio of this company will purchase it and regret it later.
This is why it becomes important to look at every single factor of a company before buying it.
D.Don’t fail to consider time as well as price before buying a true growth stock:
According to the author, we should buy a stock at a certain date rather than a certain price.
For example, if the price of Tata Motors is at ₹320 today, and the company says it is very optimistic about its future, but you’re unsure about it. You should wait until the next quarterly reports to release, see if the sales are increasing, whether the auto industry is showing positive growth, and then buy.
E.Don’t follow the crowd:
A stock’s price doesn’t always move for the right reasons. As we have seen many times, certain negative or positive rumors, which may or may not be true, can lead a stock’s price to go up or down significantly. We should evaluate these rumors properly before making a panic purchase.
Certain groups of people always try to manipulate us by spreading fake news about a company.
We should never purchase or sell a stock by following the advice of other investors.