Tags: feel | stocks | company | products

Common Misperceptions That Trip Investors Up

By    |   Monday, 04 November 2013 07:16 AM

Have you ever seen a guy or lady dating someone who is no good for them? They make bad judgments because their emotions cloud them from making a rational decision and from seeing things how they really are.

They'll say things like, "I know he's addicted to drugs, but I just love him." or "I know she's an alcoholic, but I still want to date her."

People make irrational decisions that aren't in their better interests because of the "emotional feeling" they have about the person at the time. Little do they realize, these addictive personalities will likely be very selfish and drain their potential partner both emotionally and financially.

Well, did you know investors do the same thing? Their judgment gets clouded by how they "feel" about the company or its products rather than objectively assessing the facts. Let me give you a couple of examples.

Probably a year or more ago, a lady I know asked me if she could pick my brain on some financial matters. So I told her that would be fine. I'd love to help her out.

Her question boiled down to what she should do with her investments since she was being forced to take a severance package from her employer due to the severity of the recession.

We looked at what she was invested in, and it was largely in company stock. She asked my thoughts about her stock. So I pulled up the fundamentals of the company on my phone and began to tell her how the fundamentals of this company weren't good anymore, in my opinion and that her money would very likely be better served by putting the money in a more stable company.

Well, in the end, she decided to just stick with the company stock in her portfolio. What happened? The stock dropped from the $25-$30 range down to the $7s as of this writing. That's a three- to fourfold decrease!

Why did she stick with the stock despite my objective analysis of the company? It was likely due to how she "felt" about the company and its future and the time she'd put in at the company.

While it's fine to draw a paycheck from a company like this, it's another matter entirely as to if it would also be investment worthy. In this case, it was not investment worthy, in my opinion.

Then, this week, I had a guy I know contact me about investing. He said he didn't contribute to a 401(k) because he didn't trust that, but he bought his company's stock because he trusted that.

Well, once again, the guy liked it because he worked there and because the stock had been going up nicely for a long time. However, once again, these are not good reasons to buy or continue buying a stock.

For starters, I told him, your 401(k) is tax deferred and you can invest in a more diversified way, which can carry much less risk than buying one stock is. Secondly, the company stock that he "felt" so good about was getting very overvalued fundamentally and technically on the chart, too.

So his "feeling" was really misleading. The emotional comfort that comes and the facts can be (and usually are) two different things. In fact, some of the best buys out there are usually emotionally uncomfortable to make, yet the right decision to make more times than not.

Also, what else do we become more enthused at buying as the price rises? Do we like buying houses at higher and higher prices? What about gasoline, food or clothing? No, we only get this screwy about our thinking when it comes to stocks. Yet we should think about them just like everything else in our life and get excited about obtaining them when the prices are lower, not higher.

Another thing that can make an investor "feel good" about a company and want to buy it can be based on their familiarity with it or what they think about their products.

Just because a company makes a product you like has nothing to do with whether they are in great fundamental shape as a company OR that the stock is trading at a favorable price worthy of investment.

Many investors got into Facebook due to their familiarity and use of Facebook.com. Others like the concept of electric cars and think that Tesla makes a cool-looking car. Therefore, they want to buy the stock.

If you like the products, by all means buy or use the products or services. But don't confuse how you "feel" about their product or service with how good of fundamental shape the actual company is in. Also, even if the company is in good shape fundamentally, as far as it lasting and the likelihood of it being around for a long time, it still doesn't mean that its stock is trading at a favorable price relative to its level of earnings or assets that it owns. One can overpay for anything in life, especially stocks.

The problem is that the average person usually realizes when they are overpaying for bread, milk or gas, but they don't always know if they're overpaying for a stock because a novice investor doesn't know how to properly value a company.

Therefore, when it comes to a stock, never ask yourself how you "feel" about the company. Instead ONLY invest on the facts that you see about the fundamentals of the company and its valuation, etc.

Heck, I've made money off of companies that were trading at a great value, yet I didn't even personally like or use their products or services.

While that may seem hypocritical to you, it's not. Here's why. Just because I don't like their product doesn't mean millions of other people don't like their product. You see, I know that my opinion (or tastes) isn't the same as that of the masses. So I can never gauge it off of that.

For instance, I'm getting to where I like Wal-Mart and McDonalds less and less all the time. In my opinion, they're getting to where they don't hire quality workers anymore and they certainly don't train them that well. The service isn't nearly what you get from somewhere like Target or Chick-fil-A.

Yet, if these companies got to a compelling fundamental valuation, it would make sense to own either of them.

So what is "investment worthy" and how we "feel" about a stock should always stay worlds apart from each other. Yet much of the time, novice investors mix the two. If they feel good about a company or its products and services, they'll buy it and if they don't feel good about it, they won't.

But feelings alone will almost certainly mislead the investor over time. Make sure to stick to the facts.

God bless!

About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust.
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Just because a company makes a product you like has nothing to do with whether they are in great fundamental shape as a company OR that the stock is trading at a favorable price worthy of investment.
Monday, 04 November 2013 07:16 AM
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