5 Investing Don'ts

In seven years of writing for the Fool, I've never devoted a column to Philip Fisher, a man who made his name (and made it permanent) with the classic book Common Stocks and Uncommon Profits. It's surprising (to me) that I haven't written about Fisher, not only because we almost share a last name, but because he and I share several similar investing beliefs.

When I wrote Our Irrational Stock Market three weeks ago, a reader sent an email saying some of my ideas sounded close to Fisher's. When I told him I hadn't read Fisher's famous book in its entirety, he was aghast. This exchange made me pull the book off the shelf again and flip through it, and I soon remembered why I had only partially read it.

First, most chapters are well outlined and bulleted. Second, most of the bullet points are 100% agreeable, and when you agree with something -- and feel you've always agreed, even though you surely haven't -- you're much less inclined to read the "whys" and "hows."

This could mean that many of you will skim over the following five bullet points and, in agreement, move on as well. Even so, they're worth sharing. Plus, after Rex Moore's 12 Investing Must-Knows, it makes sense to look at these "Five don'ts for investors," as written by Philip Fisher decades ago and reflected on today.

1. Don't buy a stock just because you like the "tone" of its annual report.
We're all sitting in front of our monitors thinking, "I'd never do that," but in actuality, many of us have been wooed by a colorful, slick annual report. In 1999, investors were wooed by much less.

We should never forget that financial performance is the driving force behind every stock in the long run. Everything else is noise. A well-written annual report sporting impressive graphics means nothing compared to the financials that follow. The financials can tell a company's destiny, while an upbeat letter from the CEO -- often penned by public relations people -- tells us only what we want to hear. Given this, the fancier a company's annual report, the more cautious I become.

It's for this reason that I really appreciate the annual reports issued by the likes of eBay (Nasdaq: EBAY  ) , Amazon.com (Nasdaq: AMZN  ) , Paychex (Nasdaq: PAYX  ) , and, this year, Intel (Nasdaq: INTC  ) . Reports from these companies have been little more than a copy of the annual SEC statement with a short letter attached. Few or no pictures. No "rah-rah." All business.

The less a company spends on its annual report, the smarter it is financially -- and the less it needs to impress investors with frill. It impresses where it counts: with results.

2. Don't assume the high price at which a stock may be selling in relation to earnings is necessarily an indication that further growth in those earnings has largely already been discounted in the price.
This is a dangerous but important investment "don't." It's dangerous because many highly priced stocks are indeed overpriced and will eventually fall, while only a small minority that look overpriced will continue to rise. Those few that do keep rising, though, could make your investment career.

Early buyers of Wal-Mart (NYSE: WMT  ) , Starbucks (Nasdaq: SBUX  ) , and so many "perpetually overvalued" stocks know that the market values profitable growth over anything else. So, if a company continues to grow quickly enough to please investors, its stock may continue to rise even when it already looks overpriced.

By far, my most successful investments have been in fast-growing companies that looked absurdly valued, but kept growing so quickly that they rapidly outgrew their valuations. eBay, Amazon, more recently Netflix (Nasdaq: NFLX  ) , and AOL in the past come to mind. By buying only the "top dogs" in each respective industry, you avoid all the also-rans -- the stocks more likely to deflate -- and you'll also avoid Fisher's (and our) next investing "don't."

3. Don't overstress diversification.
The Fool has always suggested owning anywhere from eight to 14 individual stocks (if investing beyond index funds), and no more unless you have plenty of time for research and love to do this stuff daily. I follow stocks for a living and I don't want to own more 12 to 14 positions -- companies I know and understand -- so it's likely this is a good top limit for most of us.

Not only is it difficult to maintain deep knowledge about more than a handful of stocks, but owning too many will also reduce your total return. Focused investing is a great forte -- own what you believe in most, and watch those few companies very closely. Much of my portfolio is dominated by a few big, long-term winners that, without good reason, aren't going to be sold anytime soon. I'm comfortable with that. Own only as much (and as many) as you're comfortable with.

4. Don't quibble over fractions of a purchase price.
I've done it. You may have, too. You finally decide you're going to take a new position in a stock, and then the day you go to buy, you decide to enter a price slightly below the ask price -- "Why not save a quarter per share?" But the stock keeps rising without you, until eventually you're forced to pay up, paying more than you would have originally.

In extreme cases, you might stay stubborn and still not buy -- despite weeks of research and a positive decision -- because you're waiting for "your price," which was randomly set a quarter below the recent asking price. Meanwhile, the stock runs away. Costly.

And crazy. Once you've decided that a stock is a good value and worth buying, buy it. Don't quibble -- as Fisher wrote -- over fractions. In more cases than not, quibbling burns you. I've tried to figure out why this is the case, and came to this conclusion: Most of us are drawn to purchasing a stock as it's rising. So, when we watch a stock rise while researching it, and finally decide to buy, it's usually rising at the time. To then enter a limit order below the going price defies the very reason we wanted to buy the stock: Because it's a good company on the rise.

Making matters worse, if the stock begins to dip, we might rescind our purchase order, deciding to wait and try to get it even cheaper. As long as it's falling, we wait. When it starts rising again, we hesitate, until eventually we end up buying it higher than the original price. Who has ever done this? Well, it's time to stop -- or don't start. Once you're convinced, act on it.

5. Don't be afraid of buying on a war scare.
This Fisher advice from decades ago was especially relevant this year. I shared the same sentiment in January as I wrote If War Comes. The stock market almost always declines on the prospect of war, declines when war starts, and recovers and rises soon after.

What I found especially interesting in Fisher's book, though, are the following thoughts:

What do investors overlook that causes them to dump stocks both on the fear of war and on the arrival of war itself, even though by the end of the war stocks have always gone much higher than lower? They forget that stock prices are quotations expressed in money. Modern war always causes governments to spend far more than they can possibly collect from their taxpayers while the war is being waged. This causes a vast increase in the amount of money, so that each individual unit of money, such as a dollar, becomes worth less than it was before. It takes lots more dollars to buy the same number of shares of stock. This, of course, is the classic form of inflation. In other words, war is always bearish on money... Money becomes even less desirable, so that stock prices, which are expressed in units of money, always go up.

We've certainly seen the value of the dollar decline sharply against foreign currencies as the government sells debt, but we haven't seen consumer inflation yet. With luck, we won't. But odds are strong that our low-inflation environment -- like everything -- won't last. Cycles are a given.

Have a great weekend.

Of stocks mentioned, Jeff Fischer has positions in eBay, Paychex, Netflix, and Intel. The Fool has a full disclosure policy.


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