It sounds crazy, but you can know too much about a stock.
This is hard for people to accept in our “Knowledge Is Power” society… where the Internet puts thousands of pages of information, data, and news about a company in front of us with a few clicks of a mouse.
People like to believe that with enough information, they can make a perfect decision… That by adding fact after fact, data point upon data point, their understanding becomes increasingly clear. But it doesn’t always work like that.
In the field of behavioral finance – essentially the study of how people make decisions surrounding money – studies have repeatedly shown that humans usually gather too much information… and sometimes get stuck in the process.
Picking a stock, bond, or fund isn’t an exact science. Often, it means letting some facts and data go.
Don’t misunderstand… I’m not saying you should dive into the market half-cocked, throwing money at every hunch and tip that comes along. (And if you saw the blizzard of magazine clippings and journal pages spilling from my desk, you’d be tempted to call me a hypocrite.)
You do need to understand the companies you buy.
But don’t spend so much time collecting data that you get into the trap of knowing too much, and then forgetting to take action…
People can easily be paralyzed with indecision. At a certain point, investors can get lost in a sea of ratios and statistics that don’t add to their understanding of the investment.
For example, you could have a stock that looks expensive based on the past 12 months of earnings and just missed earnings by $0.02 in yesterday’s earnings announcement, but looks like a steal based on “consensus Wall Street estimates of future 12-month earnings.” What are those conflicting signals telling us? Which are important? What can we ignore?
Honestly, what does something like the debt-to-equity ratio tell you that net tangible assets growing over three years doesn’t tell you? Is that distinction vital to buying the stock? Heck no.
Don’t get bogged down in old data…
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I follow the work of an English clergyman named Reverend Thomas Bayes to guide my investing strategies. In a paper published in 1764, the reverend and mathematician outlined a method of assessing probabilities now called Bayesian statistics… In the simplest terms, it represents common-sense investing.
Bayes believed it was important to integrate your past experiences while looking at data – creating what he called “priors” – in order to create a probability of something happening in the future. It turns out, the human brain does this well… as long as it doesn’t get emotionally attached to the earlier decisions. For investing this is critical to understanding.
Modern-day author Malcolm Gladwell wrote about this ability in his book Blink: The Power of Thinking Without Thinking, which I highly recommend.
When I analyze stocks, I stick with a time-tested and simple strategy…
I simply search out companies with long histories of growing or stable sales. If a company has endured lean years in the past and has come out strong, it can probably do it again in the future.
We want to see healthy cash flows because they tell us the company is making cold, hard cash and not just reporting accounting tricks with its earnings (like with Enron).
And we want to see a clear pattern of rewarding shareholders with dividends and stock buybacks. Dividends compounded over time are the most consistent avenue to big returns.
I’ve told subscribers many times that “dividends don’t lie.” Companies can’t fake a cash payment like they can manipulate other items on the balance sheet. If you’re going to cut a dividend check, you have to have the cash to cover it. And a rising dividend is like a magnet drawing shares higher.
Just remember that when you buy or sell something, do it based on the facts of the past plus your experience. Then combine those into expectations (probabilities) about the future. And avoid anchoring your current decision to a past decision. For example, cut your losses early if the trade isn’t going your way… Don’t stick with it just because you bought the stock.
What We’re Reading…
- Three clues for finding companies that jump off the page.
- Four simple rules of thumb to stop losing money.
- Something different: Want to take a trip around the moon?
Here’s to our health, wealth, and a great retirement,
Dr. David Eifrig and the Retirement Millionaire Daily Research Team
March 6, 2017