It's possible to avoid bad-judgement calls in stock investing

It's possible to avoid bad-judgement calls in stock investing

Stock market is the most likely place where everyone has made mistakes—be it Rakesh Jhunjhunwala or your next cubicle colleague. The reason why Rakesh Jhunjhunwala has earned extraordinary profit is because he made fewer mistakes than all of us. To err is human but to repeat is investing. Well, this could be true for many of us. Why do we commit the same mistakes? There is a general observation that the stock market is the last frontier of human psychology. We will discuss some of the strands of this human psychology that keeps markets going, brokers happy and investors active. Let us look at some specific ways in which investors make a bad judgement call with relevance to stocks. Applying the same yardstick to all companies Many investors, who do some study before investing, apply the same yardstick for all the companies. This is a big mistake. Take for example; a mid-cap public sector bank usually has a PE ratio of 4-7 while large banks such as SBI maintain a PE ratio above 10. Now, if investors look at a mid-cap public sector bank with a PE of 4 thinking it to be undervalued, he or she will only get disappointed. Similarly, some investors define the PE ratio for their entry to a specific stock. Usually, a growth company such as Jubilant Foodworks will have higher PE ratio than Bharti Airtel, a company which has achieved the scale. Justifying mistakes by sticking to their investment It is human nature to refuse to own up mistakes. Many investors buy stocks thinking that it will go up. Even when the stock goes down continuously, they keep buying to average the cost expecting it to go up. This could be a good strategy when the stock is fundamentally strong and the market is facing bad economy. However, in normal circumstances, this is a sure shot way to lose money. The opposite is true too. Investors identify a good stock and buy. Once the stock starts going up, investors want it to come down to invest more. This is a fallacy. The very fact that stock is going up shows that investors' expectation was right. He or she should invest more as stocks prices go up and not wait for it to come down and miss the opportunity. Confusing general market euphoria with their abilities Many investors who make money during market boom confuse the systematic bull run with their intelligence and stock picking abilities. Hence, they invest using the same yardstick when the market is moving sideways or going down. The result is certainly disappointing. Misguided asset allocation and ignoring other avenues Many investors who have made money in a specific sector or type, (cap size: small, mid, or large) tend to over invest in the same type expecting similar results every time. This is clearly a wrong move. I have come across many investors who made money in small cap stocks and have a major part of their money invested in small cap. This backfires after sometimes. By the time investors realise their mistakes, the money is lost. Many investors find stocks exciting. This is true especially when you look at the stock ticker on TV showing red and green numbers changing every minute. They completely ignore other assets which are available in the market. Mutual funds, government bonds and debentures are other assets which are relatively safer and provide stable returns over a period of time. Instead of investing all the money in stocks, investors should diversify to mitigate the risks. Paying high price for good stocks Whether a stock is worth investing depends on the price investors pay to acquire it. There are many excellent companies in the stock market. Most of them are overpriced. Investors buy these stocks assuming excellent companies will also give excellent returns. This is a false assumption. Your return depends on what price you pay to acquire a stock. If you have paid a very high price, your returns will be low or even negative irrespective of how well the company did. Final words Stock investing is a great way to make money. However, investors should not confuse stock investing with speculation. Stock investing is a simple but long drawn out process. You need patience, perseverance and belief in your ability to pick the right one and give it enough time to appreciate.