3 Important Lessons Every Investor Must Learn
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
We all want to invest better, that’s why we put in so much time to learn. The best place to learn is from the world’s best investing minds. They’ve been there, made many of the same mistakes we’re either currently making or about to make. The difference is that they’ve already made it to our destination of financial freedom. If we want to speed up our journey, it’s important that we learn the following three lessons.
1. “The stock market is filled with individuals who know the price of everything, but the value of nothing." - Phillip Fisher
Tell me if you haven’t heard this one before, “Apple’s (NASDAQ: AAPL) next stop is $1,000 a share!” I could have inserted the name of any stock and changed the number and you’d have heard that one too. Whether it’s a twelve month price target or some technical support level, we are bombarded with the price movements of the stock market but few if any take into consideration the value of the underlying.
At $625+ billion in market value and with a sixth of that in cash, you can make the case for any range of valuations for Apple. With a price to earnings ratio that’s less than one times their twelve month growth rate you can even make the case that Apple’s a compelling value. With a five year forecasted earnings growth rate of 22.25% you could even make the case that Apple’s current valuation is downright silly cheap. However, if the iPhone 5 or 6 flops or they don’t ever release a TV, those growth rates could be a stretch.
Or, consider Facebook (NASDAQ: FB), a stock that now everyone loves to hate. Currently, they’re trading at a P/E to Growth ratio of nearly seven times while they are forecasted to grow their earnings by 27.5% annually over the next five years. However, with Facebook you hear more about their going public at a $100 billion valuation and the fact that the stock’s slipped from $38 a share to less than $19 but no one’s exactly sure where the value might lie, just that the price has come down considerably. The real question to ask isn’t what’s the price but what’s it worth. Of course it won’t be a static number but it’s at least a start.
The lesson here is to know more than just the price you’re paying for an investment, know the value you’re buying. If you are paying ten times earnings for a company that’s hardly growing that means you expect that company to earn back your original investment in ten years. If you’re paying 100 times earnings, at least know that its growth rate will flatten that number quickly. That’ll help you sleep more easily when the price and value relationship fluctuates.
2. "I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful." - Warren Buffett
Just because Facebook’s price has been cut in half doesn’t necessarily mean Warren Buffett’s Berkshire Hathaway (NYSE: BRK-B) will be picking up shares. Nor does Apple’s valuation necessarily mean that we’ll see him taking a bite out of their shares either. He’s made a name for himself picking up shares of companies whose share prices were severely beaten down by fear.
If there is one lesson we can learn from him it’s that when you know the value you’d be willing to pay for an asset, and it’s trading significantly below that value because the market’s afraid, that’s your signal to buy. Take his investment of $5 billion into Bank of America (NYSE: BAC) last year. In the deal he received preferred stock paying a 6% dividend which is redeemable for a 5% premium. The warrants strike at $7.14 a share and with shares now traded for more than a dollar above his strike price, he did pretty well on that deal. He had a value for BofA and when the market under-priced the company relative to that value he was buying. The world was fearful and he was greedy and now his investors are reaping the rewards.
3. "The four most dangerous words in investing are: 'this time it's different.'" - Sir John Templeton
When Facebook came public did you find yourself thinking that this IPO is different and that you’ll make a killing by putting in a market order on the first day of trading? As shares began to come down did you over allocate thinking that it’s just a temporary setback, shares are going to pop. Maybe it wasn’t a hot IPO; maybe you’ve kept going back to the same thesis that hasn’t worked before thinking that this time it has to work.
Maybe you’ve been burned by the airlines in the past. They charge so much to fly you and your luggage, they’ve eventually figure out a way to make money at it. Suppose you think that if they just merge away their competition they’ll solve all their woes and therefore US Airways (NYSE: LCC) and American Airlines will be a match made in stock market heaven. You want to get in ahead of the crowd and when you saw the news that those two might tie up you plunked down not an insignificant portion of your portfolio in hope of someday flying away with prodigious profits. This time it’s different?
Investors make a lot of mistakes on their way to financial freedom. A simple set of lessons to quicken your way to the Promised Land is three fold: Know the real value of what you’re buying, buy or sell when no one else is and for Pete’s sake quit repeating the same mistakes you’ve always made in the past. Do you want to become a better investor? Click here and learn how to invest better.
latimerburned owns shares of Apple and has the following options: Apple. The Motley Fool owns shares of Apple, Bank of America, Berkshire Hathaway, and Facebook. Motley Fool newsletter services recommend Apple, Berkshire Hathaway, and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.