Investing is simple, but not easy
It is the first and foremost point to accept in investing that “investing is simple, but not easy” and it becomes more difficult when an investor fails to avoid common investing mistakes
“Investing is simple, but not easy.” — Warren Buffett
Investing is one of the most competitive, relentless, and unforgiving methods of growing wealth. Although, one can earn high returns in the stock market by following the basic principles of investing.
These basic principles of investing are:-
- Truly understand the market
- Learn more and more about investing
- Never try to time the market
- Avoid common mistakes.
The above principle looks simple, it is so? but they are not easy to follow. However, with time and knowledge, one can get command over it.
Not all basic principles of investing require the same amount of time and effort to learn, one of them can easily learn in a short time from the experience of others.
Any Guess? Yes, I am talking about “how to avoid common investing mistakes”.
Do you know why it is common? because they remain the same for many decades.
Why common mistakes are dangerous in Investing?
If we would like to define the common mistakes then we simply say “it is nothing but a misconception about the actual facts”.
It is not like these they cannot avoid or correct, they can, but one should be an active learner and keen to investigate facts.
It is important to avoid common investing mistakes because if it cannot neglect timely then it will result in non-reversible losses.
For instance. if an investor lost 10% in the market then he/she requires to earn 11.1% profit from the left investment to recover that loss. On the contrary, if the total loss is 90% then only the big 900% profit can help him to recover a 90% loss.
6 common investing mistakes in a stock market
The mistake is a part of the learning process but common mistakes don’t require much time and efforts to learn.
The 6 common investing mistakes that should avoid for highest returns are
- Hurry to invest in Initial Public offering without checking the company’s background.
- Entry in the stock market during Bubbles formation.
- Invest in companies with inflated P/E ratio
- Stick to a company with accrue account receivables and depreciating sales revenue
- Blindly believe in assets declaration by a company
- Find value in companies with increasing debt
1. Hurry to invest in Initial Public offering without checking the company’s background.
An initial public offering (IPO), as the name suggests, it is a public offering to invest in the shares of a company.
The main purpose of issuance of shares to the public is to raise the capital for the future growth of a business.
It is obvious that the company want most of the investors to buy the shares of a company and for this purpose, they circulate the positive news about its performance.
The investors tend to believe in this news because of a limited information resource as companies are not bound to release the annual report before the launch of its IPO.
One of the examples is:
IPO launched in 2008 in a price band of 405-450 INR, the investors invest due to big brand and boom in the Energy sector.
In the first place, it was traded at 80% premium in respect to their closest competitors like NTPC Limited, Tata power. Soon, it is trading at 3Rs due to weak financial health. Thanks to financial reports!
In brief, an investor should find and check the balance sheet of a company and avoid to believe on news before investing in an IPO.
2. Entry in the stock market during Bubble Formation
A bubble formation is a part of the economic cycle during which the prices of assets rise rapidly beyond its actual value, it is followed by a sudden crash or bubble burst due to change in trend.
The losses occurred due to bubble burst impacts the worst to those investors who participated on the advice of other beginners during the bubble formations.
The bubbles can neither form nor burst in a single night. Rather, it requires months and years to form or burst.
What is the reason then, it is not visible to anyone?
These reasons are:-
- The greed of investors
- Participation of everyone in a market, whether a shopkeeper or barber, all start investing in a share
- The economy rises with nominal growth but the stock market growth rises with the speed of a rocket.
One of the bubble formation and burst example is
In the 1990s, Internet-related companies were adorable to a large number of investors. As a result, every company with a dotcom background receives a huge response from the market which result in a bubble formation
Finally, In 2002, Nasdaq falls by 78% in a single day which washes out all the gains during the internet boom.
To summarise, buy more when everyone is selling and sell more when everyone is buying.
3. invest in companies with inflated Price to earnings ratio
Price to earnings ratio (P/E ) is a ratio which is useful to identify the undervalued or overvalued company.
It can simply find by dividing the company’s current price by its earnings per share
The inflation of P/e ratio is an indicator to suspect the future fall of prices within a short period of time to align with its earnings.
It is true that the brand value of a company leads to a high price to earnings ratio but even, their P/E can hold the premium up to some level in comparison to industry P/E and competitors P/E
Be careful while selecting a company with a high P/E ratio.
4. Stick to a company with accrue account receivables and depreciating sales revenue
Account receivable is the balance amount to be paid by one company to a second company in return for the provided goods or services
It is a part of an asset in a balance sheet of a company.
It is not bad at all to give credit to customers even, it is one of the basic requirement of business to work on credit terms but if the credit cannot clear on time and accounts receivable is outpacing the revenue growth then the business starts facing problems in their day to day operations.
There are multiple reasons for the increase in account receivables. Some of them are:-
- The party who received the goods or service has short of funds to clear the dues.
- Push the stock to the distributor and waiting for clearing of stocks
- The customer is no more loyal to their vendors
The increase in account receivables impact the growth of a company as it cannot clear on time can result in a shortage of funds for the raw material to produce goods or service to sale.
5. Blindly believe in assets declaration by a company
An asset is a valuable resource owned by a company to meet debts, commitments, or legacies
It can be classified into two categories. These are:-
- Tangible Assets– These are physical items in the form of inventory, property and machinery of a company which are essential to produce the goods or services.
- Intangible Assets – These are the non- physical items in the form of patents, goodwill and trademarks of a company which are essential to generate brand value.
An asset is important for a company because
- It has a positive value in the present
- There is a future expectation for the increase of its value
- It can convert into liquidity at any given time.
- It attracts investors
The first thing, an investor observed is the assets of a company but the sad thing is it can be manipulated by the company to show their high assets to investors.
Therefore, it is the responsibility of an investor to check carefully about the company’s asset value.
6. Find value in companies with increasing debt
Debt is an amount that one party (borrower) borrows from a second party (lender) on agreed terms.
Debt is usually paid into two parts
- Principal amount – An actual amount that borrower borrows from the lender
- Interest amount – An additional amount over the principal amount on the agreed rate.
Usually, businesses borrow money in the form of debt for the growth of a company. They have an expectation that the results will be positive and they can use a higher profit to clear their debts but sometimes, the plan fails and the company even require more debt to maintain the routine operations.
Hence, the debt is the obligation of the company and has to be paid even in troubled times. This is why? every business tries to establish themselves as a zero debt company to avoid the impact of interest on their profits.
Debt ratio is a tool for an investor to measure the debt leverage.
Its formula is:-
Debt ratio = Total Liabilities /Total Assets
As a rule, the debt ratio of 0.5 and less than that are considered as a good company
- Investment is simple but not easy until and unless one doesn’t follow the basic rules of the stock market.
- In order to save money, it is better to timely avoid common investing mistakes.
- First research and then invest in an IPO
- High debt and account receivables are the enemies of company growth.
- Avoid entry in the stock market during bubble formation
- Always check the reason for the inflated P/E ratio
- Increasing account receivable and decreasing sales revenue indicates the customers are no more loyal to them.
- Assets value should observe carefully
- A zero debt company gets a better response than the company with high debt from the market