We all know that picking stocks is an art rather than a science. There is no ideal way to go about it, but there are some mistakes that you can avoid.
Here are 10 big stock picking mistakes that everyday investors make. Some of these errors are fairly obvious, while others are often overlooked.
- Buying a stock because you like the idea for a company. A classic example of this is the incredibly overpriced Tesla Motors (NASDAQ: TSLA). Many people love the idea of electric cars, but that does not make for a good company. Other examples of this include Chipotle Mexican Grill (NYSE: CMG) Bank of Internet (NASDAQ: BOFI), Amazon (NASDAQ: AMZN), and SolarCity. A good idea for a company does not equal a good company.
- Investing in a business plan instead of a company. Buying into a business plan is fine for a venture capitalist, but not for a person investing in a stock. Many investors buy some companies, such as Tesla, Shake Shack (NYSE: SHAK), and Amazon because they like the business plan. A good tip here is to look at the earnings report before the business plan. That will show you if the company actually makes money and if the business plan actually works.
- Buying a brand instead of a company. A great many people invest in brands they happen to like, such as McDonald’s (NYSE: MCD) or Disney (NYSE: DIS). Some investors also buy brands they remember from their childhood such, as Kellogg’s (NYSE: K). A strong or popular brand does not necessarily equal a good company. It is also possible for a strong brand to sustain a really weak or poorly run company, which appears to be the case with McDonald’s.
- Relying only on your personal experiences when you judge a product. A classic example of this is a person who says I won’t buy PayPal Holdings (NASDAQ: PYPL) because I don’t know anybody who uses PayPal. The problem with that thinking is that there could be millions or tens of millions of PayPal users you are unaware of. Actually, there were around 179 million PayPal users in the fourth quarter of 2015, so the service is very successful, even if you don’t know anybody who uses it. Always remember that your perspective is limited and your judgment is always clouded by a lack of knowledge and personal prejudice.
- Paying too much attention to the media. Many investors make the mistake of constantly watching the investment media. They forget that the purpose of the media is to attract attention and sell advertising, not to give you good or reliable information. As a media professional, I know that bad news and scare tactics sell better than good news. Others know that too, so the media often only tells you half the story, the bad news, because that’s what puts food on their table.
- Buying a stock only because it has a high dividend. A high dividend does not make a stock a good investment. I can think of some very lousy stocks, including Rent-A-Center, and mortgage real estate investment trusts, such as Two Harbors Investment (NYSE: TWO), that offer very high dividends. Two Harbors offered a 13.10% dividend yield, even though it was trading at just $7.94 a share on March 23, 2016. It also had a market cap of $2.760 billion and an enterprise value of $16.44 million, making it possibly the most overvalued company in the universe. The high dividend is being used to trick people into buying a very lousy stock.
- Buying a stock simply because it is fun. Okay, you should have fun investing, but you should never buy a stock simply because it represents what you enjoy, such as cars or hamburgers. A lot of questionable stocks, such as Shake Shack, are pumped up by this kind of sentiment, so always be very leery of it.
- Buying the stock, then reading the earnings report. Always look at the financial numbers, and if possible, read the earnings report before you buy the stock. Many traders in particular get burned this way. A major reason to look at the earnings report is to see if a stock actually makes money.
- Not looking at the big picture. Many people will buy a stock without examining the entire industry or business environment. A classic example of this is a person who invests in the niche grocer Sprouts Farmers Market (NASDAQ: SFM), but ignores the operations of Kroger (NYSE: KR). This is a mistake because Kroger’s subsidiaries are Sprout’s biggest direct competitors. A related mistake is ignoring direct competitors because their valuation is larger.
- Thinking of stocks as ticker symbols rather than companies. My biggest pet peeve about financial writers is the habit of always referring to companies as ticker symbols rather than by their name. This practice is dangerous because it makes investors think of companies as nothing but stocks and forget the underlying value. Always try to think of a stock as a company with products, operations, and people. That way, you will be in a better position to see if it is making money.
These mistakes are only the tip of the iceberg. Always remember that the first rule of investing is you know just enough to be dangerous. It is what you do not know about a stock that will cost you money, not what you know.
Disclosure: The blogger owns shares of PayPal and Kroger.