Do you still believe you can come out ahead by picking individual stocks? While you may be thinking about your choices, you’re probably still succumbing to one or both of the following mistakes. If you can avoid these, you may have a fighting chance. But I doubt it.
Mistake # 1: Ignoring Company Valuations
Most stock-picking investors choose stocks based on a company’s winning prospects, paying a premium price relative to earnings. You may be dazzled by a company’s exciting innovations, recent stock split, or financial talk show appearance. The news may be good for business. But remember, as a stockholder, you become a company owner. The more you pay for your stake relative to real company value, the more speculative your position becomes.
For example, in 1998–1999, Cisco Systems (CSCO) stock price grew and grew until investors were willing to pay $ 80 / share at its March 2000 peak. By then, the price was 196 times Cisco’s $ 0.41 / share earnings. In hindsight, we now know that Cisco investors were buying a great business in March 2000. As of April 1, 2022, Cisco’s earnings had increased seven-fold since then. The problem is that investors overpaid for that great business. Today, Cisco is trading at $ 55.66 / share. (BTW, Tesla’s price is 122x earnings.)
Mistake # 2: Fixating on High Dividends
I hate to break it to you, but high-dividend companies are usually slower-growing businesses, with worse prospects for share price appreciation. After all, if they’re paying out their cash to you, they’ve got less left to fuel future growth. So, before investing in a high-dividend stock, consider how much that company is bleeding out in earnings. If it keeps up its dividend distribution pace, will it be able to grow its underlying value faster than inflation eats into it?
We would advise against picking individual stocks to begin with since the odds of success are more a matter of luck than skill. By using low-cost mutual funds or ETFs to invest in the wide swaths of the global market, you’re guaranteed to win some and lose some, but with the strong likelihood of winning more than you lose. By narrowing your chances from random luck to a range of expected outcomes, you’ve got a much better approach to planning your financial future.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
John A. Frisch, CPA / PFS, CFP®, AIF®, PPC ™ founded Alliant Wealth Advisors in 1995 and has over 30 years of experience as a financial professional. In his free time, he’s an avid long-distance runner, a sport that requires discipline, patience and vision. John applies these same skills to his professional pursuits: He helps families and retirement plan sponsors adopt a patient, disciplined approach to overcoming financial challenges and reaching their distant goals along a clear path. Learn more at www.alliantwealth.com or to read past articles, visit www.alliantwealth.com/blog.