5 misconceptions about the stock market

There are some inaccurate myths in the share market which can misinform the investor. Below are a list of five common myths which are false concepts about the share market.

1.You can’t go wrong with a fundamentally sound stock

Stocks which are fundamentally strong can also fall in share price. Although the financial ratios may indicate there is nothing wrong with the company, the share market needs to believe that as well. If the sentiment of a stock in the market is negative and investors don’t believe the management, or they think there is a problem with the company, then fundamentals will not save the stock price from falling. Often once the shares have already fallen do we hear from a company that its financial metrics have deteriorated and/or the outlook has changed.

2.Investors looking to live off their investment portfolio should concentrate on income stocks

We have recently demonstrated that income stocks have not performed well over a long period of time. Investors believing that they can live off their income stocks are sacrificing capital growth for income. In our recent analysis, we identified that common income stocks have been decreasing their dividends but have also been declining in value. However, growth stocks have the ability to increase their dividend over time and will also see a rise in capital value. Hence long-term investors in growth stocks are benefiting with income and capital growth. You can read the article “Income investors should invest in growth stocks, not income stocks”  which breaks down the numbers and compares the total return of income and growth stocks.

3.You should buy stocks when they are falling

Many investors believe if a stock is falling, they should acquire more. They see this as bargain sale where they can buy more shares for a cheaper price. However, it is not that simple. The analogy of a retail store selling T-Shirts for a cheaper price is a ridiculous analogy. In this case, the T-Shirt has changed. However in the share market, stocks can be falling for a completely valid reason. This strategy of buying falling stocks can lead to the investor losing even more money because the stock price can continue to drop further. Investors should wait for the stock to bottom before buying more to ensure the stock is on its way up and not down. Remember, what goes down, doesn’t always go back up. The share market is littered with examples of this.

4.Keep stocks which are losing money and sell stocks which are moving up

There is a psychology term called “loss aversion” which means people rather avoid losing money they had than losing money they never had. Investors tend to hold on to loses for too long hoping the stock will recover and they will break even and exit out of the stock. However, what may happen is the stock continues to fall further and the investor is still hoping to eventually recoup their losses. A better strategy is cut stocks that a falling and keep stocks that continuing to head up. Assuming a losing stock does end up recovering many years later, in that time period there has been a substantial opportunity cost in not being in a better investment.

5.Stocks which have a high price cannot go up forever

Many investors believe that if a stock is priced very highly then it is too expensive and they wait for a pull back before purchasing this stock. However, if a stock is strong fundamentally and the market outlook for the stock is positive, then it will continue to climb. For instance, let’s look at the stock CSL, the initial public offering of this stock was $2.30 in June 1994 and it has climbed to $315.64 as of 4th Feb 2020. A year ago (4th Feb 2019) CSL was priced at $193.03 and some investors thought that stock was too expensive and may not continue to rise so they held off buying hoping they could get it a lower price. The stock has made 62.89% in the past year so even though $193.03 may seem like an expensive stock price, the stock has still been able to generate a high return for shareholders. There is a valid reason to buying on weakness, but many investors don’t know when to pull the trigger. This is where technical analysis can help answer the question “Is this enough of a dip, or is the stock going to get cheaper?”.

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Lauren Hua is a private client adviser at Fairmont Equities.  

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