When I was 20 years old I was working for the CPA firm that is now known as Deloitte Touche. One day at lunch a partner in the firm mentioned he was buying some obscure stock that I had never heard of because he believed it would be taken over. He sounded like a smart guy and had some money, so I set up a brokerage account and bought some too. The stock never moved very much and a couple of years later I sold it for a very small gain.
Another stock I bought back in my early days of investing was IBM (IBM) . I didn't really have any special reason for buying it other than the fact that I read about it in the Wall Street Journal and Barron's quite often. It bounced around for a few years and I eventually sold it for a loss because I had grown tired of it and wanted to use the capital more productively.
A third stock I bought was known as Phillip Morris at the time and is now Altria Group (MO) . It paid a good dividend and I liked the idea of Dividend Reinvestment Plans. I put some money into it and added to it a few times over the years. In fact, I still own the stock to this day and it has been a fantastic investment as the firm has spun off at least three other publicly traded companies and the reinvestment of the dividends worked very well.
My early approach to stock-picking was probably similar to what many others have experienced. We don't approach it in a systematic way when we first start. We accidently develop an approach and then expand upon it as our circumstances shift.
When I became more serious about investing later in life my style of stock-picking changed substantially. It became clear to me that if I really want to produce good results I had to have a method other than hot tips and impulsive decisions. We end up investing in stocks for many different reasons and most of the time we really don't have a well thought-out plan, it happens in accidental ways. We read an article that sounds interesting, someone we know offers a tip or we just like the business that the company is in.
Sometimes we are lucky and sometimes we are not.
How do you find and invest in good stocks? And, importantly, how do you do this in a way that is going to produce optimal results?
2 Biggest Mistakes
First, we have to be aware of the two biggest mistakes that people make in stock-picking:
1. Being a "True Believer." Most new investors like the idea of emulating Warren Buffett. The concept of buying a great stock and then holding for the very long term is very appealing. I had some luck with that idea with the MO investment I mentioned above but far too often people latch on to a stock and then become emotionally attached to it.
For example, I recall the stock of the restaurant concept Rain Forest Café. There were a group of people that analyzed everything from the menu to wait times. They were convinced that this was a fantastic story that would never end and they rode it to the bitter end.
We can see similar emotional attachments to stocks that have proven to be much better bets, such as Apple (AAPL) and Tesla (TSLA) , but far too often people will tie themselves up in something that languishes for years. I heard someone the other day talking about how IBM was going to be fantastic because of blockchain. Maybe it will but there is nothing in the current chart or financial projections to support that idea.
2. Acting on "Hot Tips." The much more prevalent mistake that investors make is jumping on hot tips and not having any sort of plan. In the internet age there are endless sources of hot tips. Many of them are good and they work but most people do a very poor job of sorting through the ideas and doing an objective evaluation.
Hot tips are a great source of ideas but they need to be rigorously reviewed and, most importantly, the price action has to confirm the thesis. Ultimately it always comes down to price action but what happens is that people become true believers as a way to excuse poor price action. They excuse the poor action because they "know" it will ultimately work.
Keys to Stock-Picking
The keys to developing a stock-picking methodology are:
1. Approach it in a systematic way. Don't' be impulsive in buying because it sounds good or you don't have any better ideas.
2. Make sure the price action confirms your belief in the stock. All stocks will have volatile periods but is the overall price trend support of a positive thesis?
3. Consider a combination of fundamentals and technicals. Does the technical action support the fundamental view and vice versa?
I generally start my stock selection approach by looking for price action first. Others prefer to search for good fundamentals and then hope that the price action confirms their positive view of the stock. I like the reverse method. I'd rather find a stock that has good price action and then look at the fundamentals to determine what is causing the movement.
The hunt for good stocks is one of my favorite hobbies. It is highly lucrative if done right but far too many folks approach it in a haphazard manner.
Think about why you own the stocks in your portfolio and if you can do a better job.