I have always argued that stocks cannot be summarised into one statement for a newbie, until recently when a friend told me that it could.
“Simply put, buying stocks can be likened to relationships,” he said.
I did not immediately agree, but over the next few minutes, he explained to me what he meant, and drew several analogies to back his claims.
While he is no expert, I understand that he has drawn his conclusion from his experience buying stocks for himself over the past 5 years, so I took his points seriously. These points have been summarised in this article.
When it crashes, there is no telling how far it can go
My friend mentioned of some company’s stock he bought in 2016 in the hope of selling short-term. At the time he bought, there was a dip and he expected things to pick up within some months so he could sell-off.
Two years later, the stock price had plummeted 50% down from the price at which he bought. Without saying, he became a long-term investor because he was not ready to sell off at a loss.
How does this liken to being in a bad relationship?
As the value plummets, you keep hoping it will rise again and then before you know it you are stuck for the long haul. Same thing can happen with a wrong partner. You remain there hoping things will be better but it gets worse.
It could happen sometimes that a company’s stock market price comes crashing and it never goes back to where it was again. The factors which triggered its fall, may not even be able to return it to its starting price.
The stock price is not indicative of the company’s profitability
For some reason, there are company stocks market prices that remain low year after year despite the billions declared in profits, and the dividends paid out to shareholders.
Sometimes, the stock market price could still slump even when the company has positive records in its financials. Market experts are not always able to explain this, but it remains true. Some of the most profitable stocks are undervalued.
You can never take stocks at face value
That a stock has been on an upward trend in the last few months does not mean it will remain so. One must always consider several other factors before purchasing a stock.
While it is important to look at past performance, there are other things that could point to the likely future of such stocks.
Say, for instance, the company has just announced a new board chairman who was implicated in some fraud cases in the past. It doesn’t matter how well the stocks have performed in the last 365 days, or the chairman’s competence, the stock prices are most likely to slump due to loss of investor confidence.
There was a recent case where the CEO of an internet service provider company was alleged to have been involved in sexual harassment, and was eventually pressured by shareholders to resign. The pressure came not necessarily because they thought he was guilty, but because of the implications on the company.
You have to probe to discover the real qualities.
The most expensive stocks are not necessarily the best.
If you ever heard a stock described as under-priced or over-valued, then you should understand that the price you pay is not necessarily suggestive of the value.
Some great stocks, with good potentials, high liquidity, good company profile and adherence to corporate governance ethics, are not as expensive as they should be. While some other stocks are ridiculously overpriced, even when they do not have as much promise. Some of these overpriced stocks could still be basking in past glory or just positive media hype.
This explains why investors must conduct due diligence before putting in their hard-earned money. Sometimes the media hype around a company’s stock might not be giving you all the information you need to make a decision, so you necessarily have to go the extra mile.
Subscribe to newsletters from financial news websites if you need to, take courses if you have to, but ensure to learn all you can.
Remember price is what you pay for the stock, but value is what it is really worth, and there is no law stating that one must justify the other.
When you get the wrong stocks, you get stuck!
You know that feeling when you are sure that you have made the wrong choice, but also know that there is no way out? That’s the feeling you get when you marry the wrong partner, as my friend said. And that’s the same feeling you get when you get the wrong stocks.
You simply get stuck.
No returns. No dividends. Probably, no way to sell either because no one else is interested in buying from you. And if you do succeed in selling off at this point, you would most likely be doing so at a loss.
If you study trends in the stock market, you will see some dormant stocks that have remained stagnant for long periods of time. No rise in share price, no fall in share price, and no share is being traded either.
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It is not a nice position to be in, and that is why you want to be sure of the company, its management, and board members who take the decisions before you decide to buy or not, even more so when you are a long-term investor.
And even then, with the wrong stocks, you could suddenly find that your proposed short term investment of 6 months will run into years because you keep waiting for things to pick up before you sell.