Nowadays, we are hearing stories of investors getting super rich by investing in the stock markets but there are less number of success stories as compared to failed ones. In the real world, 90% end up losing their hard-earned money. There are lots of factors that contribute to the success or failure of new investors.
Investing is a game of nerves besides every other factor, the investment period also plays a vital role in generating potential returns. Long-term plans with disciplined decisions reduce the risk of failure. New investors do not follow due diligence and that’s why investors fail in the stock market.
Why Investors Fail in the Stock Market?
Every kind of investment requires a solid strategy and discipline. The same will apply to the stock market as well. Higher returns will be generated over the period if your investment decision is based on investment rationale. Certain factors contribute to an investment failure or success:
Due Diligence
If you pick a stock without any research and homework, most probably you will end up with the loss of your capital. Due Diligence is a complete process of understanding a company’s business model, financial statements, reports, new plans, ongoing projects, and risks involved. Only a fundamentally strong company gives you good returns. Financial statements are the best source for analyzing a company where you can check present and past performance, revenue growth, debt structure, and return on capital. Compare the data with industry peers and identify unique factors why you should invest in this particular stock instead of industry rivals.
Market competitiveness plays a vital role in the growth of a company. If its rivals offer better services or products why would customers give importance to the company’s products or services? Competitive advantage puts a company ahead of its rivals in terms of growth, revenue, and ultimately profits. Market trends and future outlook will decide the future of the company. If you make a mistake and overrule the due process there are high chances you will make a wrong decision.
Do not Judge a Book by its Cover
Do not make an investment decision based on the current performance of a company and its stock value. Understand the cyclical behavior of a stock and product demand. Do not make decisions based on stock hype, tips, or broker influence instead evaluate the stock based on fundamentals and identify whether it is undervalued or overvalued. Retail investors normally invest based on market perception or they get influenced by a stock’s recent performance or rumors.
Emotional Decision Making
Buying a stock based on emotional attachment will never offer you any good returns. Make decisions based on extensive research, analysis, projections, market competition, etc. Read regularly financials such as profit and loss accounts, cash flow statements, debt structuring, directors reports, etc. This will give you enough knowledge about a company’s future outlook.
Lack of Disciplined
If you ignore your strategy and make decisions based on the current scenario you will end up in a disaster. Don’t make rush decisions, stay focused on your goals, and follow your plan with discipline. Lack of clear mind and biased decisions are the main hurdles in the way of financial independence.
Investment Rationale
Investment Rationale is the answer to why an investment is worth making. If an investor can not draw an investment rationale checklist, should not invest. This checklist includes:
- History of the company: Understand the company policies and its evolution.
- Products: What type of products do they make, either seasonal or year-around products?
- Growth potential: What are the growth potential, projects in the pipeline, and future outlook?
- Market Opportunity: Is it a mature, developing, or underdeveloped market for the products?
- Competitive Dynamics: How do they competitively perform?
- Management: Do they have experienced management and how did they perform in the past? How credible they are in safeguarding investors’ interests?
- Problems: What problems they are facing now, and how did they tackle them in the past?
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Investment Decision Making Process
Research
Research starts by reading the company reports and its competitors’ reports. Read directors’ reports and the chairman or CEO’s report. Make a horizontal and vertical analysis of profit & loss and balance sheet for the last as many years as possible. Check the independent auditor’s report on annual accounts and review reports.
Plan
Develop a strategy, define goals, and estimate risk appetite in pursuit of your objectives. Never jump in and out of a stock on a whim, always focus on long-term goals.
Disciplined
Do not panic in a tough situation and stay focused on your strategic objectives. Decisions made in a rush based on greed usually end up in loss. Never try to catch a falling knife or chase a pumping stock. Wait patiently till your price has reached.
Goals
Successful investors set long-term targets rather than short-term ones. Warren Buffet’s Berkshire Hathaway is a proven case of long-term targets, they have held Apple, and Coca-Cola like stocks for a very long time and stocks like this helped them to reach a trillion-dollar company.
Portfolio Diversification
To reduce the risk of potential loss of capital, don’t put all your eggs in one basket. Diversify your investment in different kinds of assets like high-return saving certificates, stocks, gold, cryptocurrency, or property. Even in the stock market diversify your investment in different sectors, Warren Buffet’s Berkshire Hathaway holds more than 30 stocks from different sectors.
Risk Management
When a market is performing everyone tries to stay invested without estimating potential risks affiliated with higher prices. Stock markets have a very high possibility of price volatility due to the nature of business. You can not predict what can happen unexpectedly. Every stock has different risk exposures:
- Market Risk
- Company Risk
- liquidity Risk
- Opportunity Risk
Investment Check List
Follow these simple points and try to get the maximum positive checks from the list. This will help you avoid emotional decisions.
- Is the business model understandable?
- Why do Customers buy products or services?
- Does the company offer unique products or services?
- Is the company consistently operating?
- Does the business have positive long-term prospects?
- Is there anything that can disrupt the business model?
- Can the company make continuous operations without capital investment?
- Can they adjust product prices according to the prevailing inflation?
- Have you compared the financial performance with the main rivals?
- Have the management credibility and integrity?
- Do you consider the management intelligent and energetic?
- Do you consider management rational in decision-making?
- Does the management give disclosure of problems, contingencies, and commitments?
- Does the business operate efficiently through its subsidiaries?
- Is the management growth seeking?
- Does the business offer stock options to its employees?
- Does the return on equity beat its competitors?
- Is EPS improving constantly?
- Do the profit margins grow?
- Is the return on equity, assets, and capital employed improving?
- Does the company make payouts?
- Does the Book Value Per Share justify the market price of the stock?
- Have you evaluated financial health through the Current Ratio, Quick Ratio, Inventory Turnover Time, Asset Turnover Time, Equity to Assets, Debt to Equity Ratio, etc?
- Does the company have sufficient funds for new projects and capital expenditures?
- Has the company had a track record of earning growth above the market average?
- Has the business created value equal to or above the earnings retained?
Investing Time Horizon?
Successful investors always prefer a long-term investment time horizon because this will generate higher returns. Long-term investing is so powerful that calms your nerves during the pump or dump period.
Conclusion
These are the factors that can contribute to your wealth generation over time. If you make rush decisions and play blindly following the market trends or tips from market gurus, all of your investment either gets stuck or you lose a major part of your capital.
If you want to learn investors mentality you should read Intelligent Investor by Benjamin Graham, occasionally referred by Warren Buffet.