Investing Mistakes and ways to avoid them

I?ve made my share of investing mistakes in the ten plus years that I have been managing my own money. Fortunately, these mistakes were generally made when i didn?t have a lot to invest and occurred in the early stages of my investment journey. In this post, I am going to detail some of the major mistakes I made and some of the ways that you can avoid making them also.?

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Speculative Investments

This is one that is likely to get new investors at some stage, particularly if you view the stock market as a never ending casino where you can make instant money. I started my first investments in the ?go -go? year of 2000. I was about 23 years old, making some modest income and with excess cash to deploy. I was also having an amazing time watching the action on the Nasdaq from afar in Australia. Those first few months in 2000 before the bubble burst were some crazy times. I would watch the prices for some stocks move up (and sometimes down, but generally up!) 5%-10% each day.

As a young investor, with not much experience, all I knew is that I wanted some of that action. I had no idea why the stocks were moving up in such a manner, little idea about sustainable earnings growth, wide moats, the importance of cash flow growth, or any of these key drivers of a business. All I could see were these stock prices rising and rising, and I was determined to have some of that action.

So i decided I wanted my own piece of the technology boom. I invested in a biotech company that had some patent on a ?revolutionary? protein enzyme, as well as in a smart card company whose aim was to manage smart card installations ?around the globe?. I had no idea at the time about how either of these companies would make any money,whether these were businesses with any form of sustainability, or even whether they had a wide moats or strong ?barriers to entry.

In any case, I plonked down $2000 of my hard earned money into each of these businesses. Unsurprisingly, both were placed into administration less than a year later. The biotech company invested so much in trying to get their discovery through the various stages of FDA approval, that they had completely burned out their cash within 12 months. The smart card operator threw away whatever cash they had raised in trying to convince various governments to install smart cards,.pretty soon they were left with nothing in the bank either. So for my first 2 investments, I was 0 for 2. Literally $0 for 2!

So how do you avoid making this kind of mistakes?`

Look for a company with good business fundamentals. These include things such as solid barriers to entry, defensible competitive positions and wide moats. In particular, I now look for solid revenue growth and sustained cash generation. Had I bothered to even look for one of those things with those 2 investments, then I would have certainly safeguarded my money and avoid some nasty losses. Penny stocks can be interesting, fascinating even. If you don?t understand them, odds are you will get burnt at some point.

Investing on the basis of a takeover

Having an investment in a company that is being acquired can result in a very good exit for an investor. When this occurs naturally, as a result of an investment that you have in a company, then that is ?a good outcome. However chasing a takeover can sometimes leave you in a bad spot.

In 2007, I recalled reading some speculation about the possibility that some private equity firms were interested in Sallie Mae, the student lender. On the basis of some of those reports, I decided to invest on the prospect of some easy money. And of course, JC Flowers obliged with an indicative takeover offer which sent the stock up some 20-30%. A number of things started to happen in 2007 in the student lending market however. The government wanted to take an axe to student loan subsidies, which would have impacted the profitability of student lending, including for lenders like Sallie Mae. There were suggestions that JC Flowers may cut the deal or even walk away from the takeover. I began to get a little nervous and decided to take out whatever small profit I had made. ?It was purely luck that I managed to exit before the takeover came crashing down. JC Flowers wanted to walk away from the deal, and the share price of Sallie Mae started to rapidly decline.

Where you have invested in a company that has good economic prospects, and strong barriers to entry, that will naturally attract acquirers to such a business who will also want to benefit from those same economics. However chasing a business on the basis of a possible takeover can be a recipe for disaster if you aren?t careful. There are many complex factors that go into whether a takeover ultimately takes place or not, and you could end up on the wrong side of a takeover if you haven?t done your research.

Undisciplined use of buying on margin (margin lending)

I have previously written that I have made and still make use of ?buying on margin. Previously buying on margin was a significant part of my investing strategy. Nowadays, much less so. In fact I use very little margin, and its generally only used to strategically time / accelerate purchases.

One of the things to manage with buying on margin is not to get carried away with it. A little bit of margin can nicely boost your investment returns and return on equity. Too much margin can leave you running to sell down stock, or to raise cash to prop up your account balance to avoid a margin call.

In 2008, I was one of the many people who happened to get carried away with high levels of debt to buy stocks. As stock prices soared in 2007, so did the level of debt that I would look to put against stocks. In some ways, in was a little like 1999/2000 all over again. You would think I would have learned my lesson. I thought I had too. Instead of investing in speculative tech stocks with no revenue and no earnings, I picked what I thought were big blue chip banking stocks on juicy dividend yields.

In fact, going into 2008, as stock prices fell, I thought I was ?averaging down? and would continue to buy more. I thought this was going to be a prime time to pick up some solid dividend income from ?some very dependable companies. I was using margin to buy more and more of Bank of America, Citigroup. Unfortunately for me, the stock prices of these companies kept falling and falling. Eventually, I wasn?t able to keep buying down and had to sell stock at lower prices that what I bought for. To make matters worse, they also cut their dividends as well.

Buying on margin can improve your returns, but its crucial to manage your use of margin properly. Excessive margin can leave you scrambling if markets crash or things turn negative.

Rushing in too soon on bad news

Markets certainly overreact to bad news. I?ve seen this play out on many occasions. A stock gets negatively punished for a bad quarter miss, or a product recall or some litigation issue. It eventually bounces back once markets realize that this isn?t the end of the world for the business. ?This presents opportunities for the patient value investor, who can look beyond what should be temporary business issues and see long term value.

How markets assess and value bad news can play out over a considerable period of time however. A one time drop in a stock doesn?t mean that will be the end of it, or that the market has full priced in all the bad news.

Sometimes being too eager to pick up a bargain on bad news can actually undermine your ability to extract maximum value as a patient investor. I have made this mistake on a couple of occasions.

I was very attracted to BP in the wake of the oil spill. The oil spill disaster that BP faced a few years ago was clearly one of ?great human and natural proportions, no question. But I suspected that BP ?would be able to rise beyond this. So at the first of the large drops in BP stock, I bought. As the stock dropped, I bought again. Yet BP stock continued to drop. I eventually picked up a reasonable holding of BP stock. Yet I was cautious in buying more aggressively as the stock dropped more and more, because I had moved too soon and accumulated too much of a holding. Ultimately, this constrained me from really being able to maximize my total return from this stock.

Similarly, I have made a substantial investment in an Australian company called Cochlear, which develops Cochlear implant technology that is used for the profoundly deaf. Cochlear is one of my favorite businesses. A large moat, strong barriers to entry in an industry that has greater than 10% growth year on year, and still has lots of potential. Cochlear is the market leader with 70% market share. I had always wanted to buy the stock, but it was always too expensive too me.

In 2012, opportunity knocked. Cochlear stock plunged on a voluntary product recall that the company undertook. I moved in straight away. I wanted to accumulate a large holding. Again, I moved to soon. The price dropped, and dropped, and kept dropping. From $70, the stock when down to $60, and then to $55. I made my first large move at $57. The stock continued to drop further. I made another large move at $52. And still the stock continued to drop, all the way down to $45.

I became a little nervous to continue to add, because my exposure had become quite large, and I wasn?t sure how much further the stock would continue to fall. Yet ironically, this was a business that I was quite prepared to hold for years to come. But because I had moved into the stock too soon on bad news, my flexibility to buy more was limited as I didn?t take the time to stop and watch.

Markets often over react to bad news, which can provide opportunities for a patient value investor. Sometimes stopping, and taking some time to assess the situation can actually help maximize your long term return, and prevent you reacting too hastily.

What are some investing mistakes that you have made?

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Source: http://www.financiallyintegrated.com/investing/investing-mistakes-and-ways-to-avoid-them/

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