Done well, value investing is a successful, safe way to invest. The logic of the approach - buying an asset for less than its underlying value - is irrefutable.
Here are five of the best mistakes prevalent in investing.
- Focusing only on the numbers One of the most common investing mistakes is to concentrate only on a stock's financial data. The big four banks, for example, all carry forecast dividend yields of about 6 per cent, and price-earnings ratios of about 14-15. Based on numbers, they're closely matched. When you consider the risks entailed in ANZ's Asian expansion and National Australia Bank's aggressive push for market share, however, the numbers suddenly don't seem to tell the whole story. These qualitative factors are why we favour Commonwealth Bank and Westpac over ANZ and NAB.
- Mistaking permanent declines for temporary ones When businesses hit rough patches, it can be a great time to buy. We've had positive recommendations on Aristocrat Leisure over the past few years for this reason. While a poor product line-up and the strong Aussie dollar were all hurting Aristocrat in the short term, we expected this business to perform well in the long run. If profits stayed permanently depressed, we'd have overpaid for Aristocrat. However, things are slowly turning around.
- Buying low-quality businesses Unfortunately, high-quality businesses are seldom cheap. Value investors therefore often end up with portfolios full of cheap but low-quality stocks, entailing greater risk. It's better to fill your portfolio with high-quality businesses, especially if you're patient and buy opportunistically.
- Neglecting economic considerations ''If you spend more than 13 minutes analysing economic and market forecasts, you've wasted 10 minutes.'' Ever since uttering that sentence, fund manager Peter Lynch gave value investors a free pass to ignore the economy. Or so they thought. You can't completely ignore the economy, but the success of your investments should never rely on specific, short-term forecasts. An investment in Rio Tinto, for example, hinges largely on the continued strength of China's economy. That's an economic forecast we're not willing to gamble on at current prices. An appreciation of cycles should underpin your stock purchases and disposals.
- Ignoring the market A healthy scepticism of the market's wisdom is vital. When you're right, the rewards can be enormous. The market wrote down RHG Group from $0.95 to $0.05 before Intelligent Investor Share Advisor's positive recommendations were vindicated. But when you're wrong, it can be bad. Backing ourselves explains why we were too late in pulling the pin on Timbercorp. Share-price movements should never influence your analysis. But they can offer a timely prompt to reconsider your thinking. When you're going against the grain, make sure you know why you disagree with the market.
This article contains general investment advice only (under AFSL 282288).
Nathan Bell is the research director at Intelligent Investor Share Advisor. Money readers can get a free trial and a special end of financial year offer
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