Avoid These Mistakes When Buying Individual Stocks
Does the thought of stock-picking appeal to you? As you evaluate your options, you may come close to making one or both of the following mistakes.
Mistake #1: Ignoring Company Valuations
Many stock-pickers choose stocks based on a company’s perceived winning prospects and pay a premium price relative to earnings. You may be dazzled by a company’s exciting innovations, recent stock split, or financial talk show appearance. The news may be good for business. But remember, as a stockholder, you become a company owner. The more you pay for your stake relative to real company value, the more speculative your position becomes.
For example, in 1998–1999, Cisco Systems (CSCO) stock price grew until investors started paying $80 per share at its March 2000 peak. By then, the price was 196 times Cisco’s $0.41 per share earnings. In hindsight, we now know that Cisco investors bought a solid business in March 2000. As of April 1, 2022, Cisco’s earnings had increased seven-fold since the peak in March 2000. The problem is that more recently, investors overpaid for that business. Today, Cisco is trading at $55.66/share.
Mistake #2: Fixating on High Dividends
Unfortunately, high-dividend companies are usually slower-growing businesses, with worse prospects for share-price appreciation. If they pay out their cash to you, the company has less to fuel future growth. Before investing in a high-dividend stock, consider how much that company is bleeding out in earnings. If it keeps up its dividend distribution pace, will it be able to grow its underlying value faster than inflation eats into it?
Successful stock picking is usually more a matter of luck than skill. You’re likely better off investing in low-cost mutual funds or exchange-traded funds (ETFs) to invest in wide sections of the global market. You win some and lose some, but we believe it’s likely you’ll win more than you lose in the long term.
This is intended for informational purposes only and should not be construed as personalized investment advice. Please consult your investment professional regarding your unique situation.
The securities identified and described were provided for illustrative purposes only and do not represent securities recommended for client accounts.