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Author: Valueinvestor91 One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 2674  
Subject: 10 Reasons for under performance, and a few..... Date: 10/29/2005 11:34 PM
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10 Reasons for under performance, and a few stock market myths.




"To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework."

1. - Warren E. Buffett, Preface to "The Intelligent Investor" by Benjamin Graham


1. Don't Follow the crowd.

I don't know if you have ever heard of the “Tulip Craze.” It is often studied by psychologists, economists and market observers. And if you've never heard the story, you won't believe it's true. But it is. It really happened.How bad did it get? Well, at the height of tulip mania in 1635, a single tulip bulb was sold for the following items:
• four tons of wheat
• eight tons of rye
• one bed
• four oxen
• eight pigs
• 12 sheep
• one suit of clothes
• two casks of wine
• four tons of beer
• two tons of butter
• 1,000 pounds of cheese
• one silver drinking cup.

The present day value of all these items? Nearly $35,000! Can you imagine spending $35,000 for a single tulip bulb? This was happening in Holland in the mid-17th century. It was getting so bizarre that people were selling everything they owned – their homes, their livestock, everything – for the privilege of owning tulips, on the expectation that the bulbs would continue to grow in value. Many people got carried away on technology and internet stocks, believing the hype that the industry would keep outgrowing every other for years to come, if not forever. But we all know what happened in 2000-03, the boom of the internet came crashing down with most internet stocks losing over 50%.

2. Keep transaction and brokerage costs low.

I was not to thrilled to find out that in my Scottrade account my total transaction costs for my 3 and a half years of investing amounts to over $400. Considering that I have only $6,000 that's about 7%. No I am note a day trader, I actually make about 1 trade every month. That's not a lot of trades, they really add up. But if I was a day trader and I made 1 trade every day. I know most day traders make more than 1 trade a day but I use that anyway. Subtracting for weekends there are 261 days that the market is open excluding holidays. 261*$7 is $1,827 in transaction cots alone in one year. If you make 10 trades a day which some traders do it would amount to $18,270 per year. If you make even more trades the costs are obviously going to be more, and most likely the cost per trade is not going to be $7 which I used because that's what I pay per trade. Online trading clearly encourages rapid trading but it can also save you a lot of money. Could you imagine trading ten times a day in a brokerage that charges 1-2% per trade, no way.

3. Diversification.

I have $6,000 and I own 1 share of class B Berkshire Hathaway at about $2,800 per share. Isn't that risky you say. Well I never thought twice about my investment in BRK.B because it has over 30 operating subsidiaries in very diverse industries, almost all of these company's were bought cheap and are great businesses like Geico Auto Insurance, Dairy queen and many more. It has great management which I clearly understand how they run the business. I also share many of Warren Buffets beliefs on investing. Best of all Berkshire Hathaway is very out of favor with the market right know. I believe brk.b is a great investment right know that's why I am ok with placing half my money in just this one company. I know lots of people that try to buy stock in at least one stock in every industry. I don't believe in this. I think that owning between 3-9 different company's that you can understand and keep track of. I think it would be fairly hard to keep track of 100+ stocks at a time.

4. Investing in mutual funds.

Mutual funds were designed to diversify the portfolio with little risk and beat the market average with professional managers. But with their high fee's and other imperfections they seldom out perform the market averages. Remember most mutual fund returns are before taxes and fee's which can fun as high as 2%. But there are some funds that do a great job for their investors most are run by value investors. I found something interesting while reading the book Beating The Street by Peter Lynch. Evidence that you can beat the market with a disciplined approach comes from the National Association of Investors Corp. This organization represents 8,000 stock picking clubs. The NAIC reports that 62% of it's chapters have done better than the S&P 500 average over their entire history 10 years or more. Most of their success comes from investing on a regular time table taking the guesswork out of timing the market. I would like to stress that for most investors investing in common stocks is unnecessary and unadvisable. The fact that most professional managers do a poor job of stock picking does not mean that most amateurs can do any better. A small percentage of investors can excel at picking their own stocks. Everyone that is not gifted in picking stocks, does not just need to go out and get a broker. An investor in this situation can still successfully invest ideally through an Index fund. For example the S&P 500 or Dow Jones industrial average . You can also try investing not with real money by using portfolio tracking sites such as www.Morningstar.com , www.finance.yahoo.com , www.marketocracy.com . By test driving your techniques before trying them with real money, you can make mistakes without actually incurring any actual losses, develop the discipline to avoid frequent trading, and learn what works for you. Tracking the outcome of all your stocks will prevent you from forgetting that some of your hunches turn out to be stinkers. That will force you to learn from your winners and losers. At the end of the year measure your return against what your return would have been if you would have put all your money in the S&P 500 index fund. If you didn't enjoy the experiment or your results were poor, no harm done selecting stocks is not for you. Get yourself an index fund and stop wasting your time on stock picking.

5.Due your homework.

Don't invest in a company just because it has an A+ or whatever from an analyst. Read the company's 10-K it starts by explaining the business. Then read the financial statement remember to read the small footnotes that's where the management likes to hide the bad stuff. Find out what the product is, is it a sound product, does it have a competitive advantage or is it just your average Joe, is management trying to create shareholder value, does management own shares of the company usually if they do their interest are were yours are. Through the Edgar database at www.sec.gov, you get instant access to a company's annual and quarterly reports, along with the proxy statement which discloses the manager's compensation, ownership and potential conflicts of interest.


6. The Efficient Market Theory.

The Efficient market theory claims the price of each stock incorporates all publicly available information about the company. With millions of investors scouring the market every day it is unlikely that severe mispricings can persist for long. An old joke has two financial professors walking along the sidewalk when one spots a $20 dollar bill and bends over to pick it up, the other grabs his arm and says, “Don't bother. If it was a really $20 dollar bill, someone would have taken it already.” While the market is not perfectly efficient it is pretty close most of the time so the intelligent investor will stoop to pick up the stock markets $20 dollar bills only after researching them throughly and minimized the costs of trading and taxes.

7. Using the BETA to determine risk.

One quick example of the basic flaw in the beta. The Washington Post Co. In 1973 was selling for 80 million in the market. At that time, you could have sold all the assets of the business to any one of ten buyers for over 400 million. The same properties are now worth over 2 billion. So the buyer at 400 million would not have been crazy. Now if the stock had declined even further to say 40 million the beta would have been greater and for those of you who think beta measures risk the cheaper price would have looked a lot more risky. This is truly Alice in Wonderland I have never been able to figure out why it is riskier to buy 400 million worth of assets for 40 million than 80 million. (Example taken from The Intelligent Investor). This is clearly less risky buying stock at a cheaper price is a lot less risky then buying at a higher price. So the beta is pretty much useless.

8.The stocks gone up, so I must be right, or
the stocks gone down so I must be wrong.

People often take comfort when their recent purchase of something at $5 a share goes up to $6, as if that proves a good investment. Nothing could be farther from truth. Of course if you sell at this price you have made a dandy profit, but most investors don't sell under these favorable circumstances. Instead they convince themselves that the higher price proves the investment is worthwhile, and they hold on to the stock until a lower price convinces them the investment is no good. If it's a choice, they hold on to the stock that has risen from $10 to $12, and they get rid if the one that has fallen from $10 to $8, while telling themselves that they have “kept the winner and dumped the loser.”

9.Splits and share prices.

Whether a stock is selling at $.25, $1, or $85,000 makes absolutely no difference. It is the total market capitalization that makes the difference. Berkshire Hathaway is trading for $85,000 per share, has a total market capitalization of 130 billion with 1.54 million shares outstanding. If they were to split 85,000 to 1, the shares outstanding would increase to 130 billion and the share price would go down to one dollar, the total market cap. Would still be 130 billion, the value did not increase or decrease any. A stock is not cheap just because it is trading at $3 as apposed to trading $10 per-share. The price per-share alone means absolutely nothing.

10.When it rebounds to $10, I'll sell

The worst possible thing you can do is to say I will wait for the price to get back up to $10 and then I'll sell. Your speculating and whenever you speculate you will most likely lose money. If you say that or think that you are not investing because you like the company's prospects. When the company is no longer undervalued or it's business prospects have diminished you should sell. If the stock has just fallen due to downward pressure and the business is still intact it is just a better bargain at that lower price.


Comments are welcome, Alexbossert@yahoo.com.
~Alex
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