Friday, November 12, 2010

Mistakes of a young investor

I remember making a lot of downright dumb mistakes when I first started investing (most of the major mistakes I made was before I discovered the magical world of value investing). And while I still have much to learn and many more mistakes to make, I believe I picked up some really valuable, common sense lessons from when I just started out on my journey as an investor. Here are some of the mistakes I made and, hopefully, learned from:

Don’t sit on your hands when a great opportunity is in your face

I missed quite a few opportunities to get invested in some really great companies at really attractive prices, all because I was foolishly waiting around for those stocks to drop a few more percentage points, only to see them soar to prices that might no longer be very attractive. I believe I would have done much better had I just bought shares in those companies the moment they became undervalued instead of waiting and trying to time the market.

Size doesn’t matter

Unlike a cheeseburger or an ice-blended mocha, size generally shouldn’t influence your decision of whether or not to invest in a company’s stock. The things that you should consider when valuing stocks are the return on equity, balance sheet strength, profit and revenue growth, the profit margin, the strength of the brand, and etc.

If I knew this early on, I wouldn’t have invested in a few big companies that had really mediocre fundamentals, which I discounted with the very misplaced believe that the sheer size of those companies will make everything workout, and I will make money no matter what (I did make a little bit of money when I finally sold them off, but I was really lucky that time, and I wouldn’t ever want to try my luck like that ever again).

Side note: While I believe that size doesn’t matter in general, I do not extend this believe to the really micro-cap stocks; I may be wrong but I think that picking really tiny companies is a little bit too risky for the average investor. How small the size of a company can get before you decide to reject it as a candidate for potential investment is, of course, up to you. I personally have invested in a few companies with market caps of below $500 million; I’m also currently valuing a company that has a market cap of only about $60 million.

Dividends matter

While size doesn’t matter, dividends sure as hell do matter. According to Jeremy Siegel, 99% of the after-inflation returns are a result of reinvested dividends. For quite some time, I didn’t really think much about dividends, as they didn’t seem like very much (maybe enough to go out for a good meal, which I, of course, did). What I didn’t know was that dividends were the bricks that will form the foundation of my future empire (even if it’s a very tiny empire; we all lose ourselves in daydreams every now and then, don’t we?).

If you’ve ever watched an episode of Suze Orman, you would probably have heard her talking about how even very small amounts spent on stuff today can compound to thousands and thousands of dollars in the future. I don’t know exactly how much future money I missed out on by not reinvesting my dividends I received in the past, and letting the power of compounding work in my favor, but I do know that it’s a lot.

Maintain ample liquidity

Earlier in this article, I mentioned that it’s important not to market time, and that we should just invest in great companies when they are trading at attractive prices. While I obviously believe that’s true, I also believe in having cash in reserve (this doesn’t include your emergency fund) to keep buying as long as the stocks you want to get invested in stay undervalued (and hopefully drop significantly more in price).

I had a couple of pretty painful experiences where I invested most of my cash in stocks that I believe to be undervalued, only to see those stocks tank some more. I wasn’t unhappy because they dropped in price, but because I couldn’t buy more. I have no doubt that those investments that I made will make me a lot of money in the future, but it would be a whole lot sweeter if I had the liquidity to buy more when those stocks fell further in value. By maintaining ample liquidity, we can really have our cake and eat it too.

It’s inevitable that we’ll make mistakes, both in business and in life. But that’s not necessarily a bad thing. In fact, some of our biggest lessons come from the mistakes we make, and that’s why we should embrace our mistakes and learn from them. It’s of course also great to learn from other people’s mistakes as much as we can, as that will help us avoid learning some lessons the hard way.  

I hope that I helped at least some of you out by sharing some of my past mistakes (even if they are really just common sense stuff). Thank you for reading, and may you always sustain good returns on your portfolio. Take care.