Do you still believe that you can stand out by picking individual stocks? Although you’re thinking about your choices, you’re probably still succumbing to one or two of the following mistakes. If you can avoid them, you might have a fighting chance. But I doubt it.
Mistake #1: Ignoring company valuations
Most stock-picking investors choose stocks based on a company’s earning prospects, paying a premium price relative to earnings. You may be blown away by a company’s exciting innovations, the recent stock split, or the appearance of a financial talk show. The news can be good for business. But remember that as a shareholder, you become a business owner. The more you pay your stake relative to the actual value of the business, the more speculative your position becomes.
For example, in 1998-99, Cisco Systems (CSCO) stock price rose and rose, until investors were willing to pay $80/share at its March 2000 high. there, the price was 196 times Cisco’s earnings of $0.41/share. Looking back, we now know that Cisco investors were buying a large company in March 2000. As of April 1, 2022, Cisco’s profits had grown sevenfold since then. The problem is that investors have paid too much for this great company. Today, Cisco is trading at $55.66/share. (BTW, Tesla’s price is 122x earnings.)
Mistake #2: Setting high dividends
I hate to tell you this, but high dividend companies are generally slower growing companies with poorer prospects for share price appreciation. After all, if they give you their money, they have less left over to fuel future growth. So, before investing in a high-dividend stock, consider how much that company bleeds in terms of earnings. If it maintains its pace of distributing dividends, will it be able to grow its underlying value faster than inflation is eating away at it?
We don’t recommend picking individual actions to begin with, as the chances of success are more a matter of luck than skill. By using low-cost mutual funds or ETFs to invest in large swathes of the global market, you are guaranteed to gain and lose, but with a high probability of gaining more than losing. By narrowing your odds from a random chance to a range of expected outcomes, you have a much better approach to planning your financial future.
The opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations to 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 spare time, he is an avid cross-country 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 take a patient, disciplined approach to overcoming financial challenges and achieving their far-reaching goals on a clear path. Learn more at www.alliantwealth.com or to read previous articles, visit www.alliantwealth.com/blog.