As an investor our goal shall always be to improve. Our last year’s performance shall be our yardstick that should guide and motivate us to improve our performance in the new year. It is also a fact that without strong investment fundamentals it is not possible to improve on your investment performances. The biggest problem that I have seen with common investors is that they try to predict future price of stock in short term horizon. Many have ruined their life in doing so and many will continue to repeat the same fortune if they try to be the fortune teller of stock in short term. With my understanding of investment psychologies of common investors I will list top 5 investment mistakes that we shall avoid in this new year 2012.
Buying stocks when everyone else is buying
This is the most common mistake of an average retail investor. We abhor the market when stock market is performing bad and we love to invest when the SENSEX is rising high. This is a problem that is inherent with most investors and the cause is short term viewing. If the stock market is doing bad for in short term there will be too much uncertainty and profit booking is tougher. During bull runs when SENSEX is only rising visualizing future gains becomes easy. But people forget that the people who really makes profit during bull runs are the ones who have invested their money in stock during bad times.
Buying only well known stocks
You must have heard people telling you that buying blue-chip stocks are the best bets. But when you will ask them what returns those stocks are giving them they will make a somber face. The reason being not that blue chip stock are bad examples but the time in which those blue chip stocks are bought makes it a bad investment. The blue chip stocks are most preferred stock of the stock market so they are always in demand. Even in worst of times you will see that the prices of these stocks have not performed as bad as other stocks. Means the price of these stocks are comparatively stable during bad times. But during good times these are the stocks that becomes most overvalued. Trained investors will never buy blue stocks during bull runs as touching such overvalued stocks is prohibited in investment logic.
Buying stock that has high P/E ratios
Even most lay investors will probably know about Price Earning Ratios (P/E) of stocks. This ratio gives us an estimate that how overvalued a stock is. We take reference to the earning/share the company is generating and use this value to compare with its market price per share. As a rule of thumb if P/E ratio (market price / EPS) is more than 15 then the stock has stared becoming overvalued. But I will suggest that one should not only use the rule of thumb to get an idea of overvalued price levels, better will be to compare the P/E ratio of one stock with its peer companies of same sector. Also one must look at the historical behavior price earning ratio of the stock for say last five years. This exercise will give an approximate idea that if the stock is overvalued or trading at profitable levels.
Buying stocks without looking at its EPS history
While we are looking at the P/E ratio of a stock it is equally important to look into the income statements and find out the historical performance of EPS for say last five years. If a stock that has appreciated the its EPS at a rate of say 10% per annum it means that the stockholders value has been increased in the same proportion. An appreciating EPS has a magical effect on market price of its stock as higher EPS means lower P/E ratios. Not many investors use the power of EPS to analyze their stocks.
Buying stocks without considering its dividend yield
A blue chip stock that has low P/E ratio, and appreciating EPS giving high dividend yield to its investors is a great stock to buy and hold. Not many stock gives consistent dividend to its shareholders. It is not hard to find high dividend yielding stocks trading in the market. Stock that yields high dividend must be the most preferred stock for all types of investors. Dividend income is said to be like risk free income for investors. If the company is making decent earnings it will eventually disburse its profits among shareholders in form of dividends. Investors often considers dividend earning as too low income and almost rubbishes it to evaluate stocks. According to me ‘dividend yield’ and ‘dividend payout consistency’ is one of the best tool we have to evaluate the intrinsic value of any stock