FOOL ON THE HILL
Stock Market Confessions

One key to investing success is overcoming your urges to do stupid things. See if you do any of these stupid things, like being swayed by the financial media, getting hopeful too quickly, and forgetting how little you know.

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By Selena Maranjian (TMF Selena)
June 24, 2002

One of my major flaws as an investor is that I have a lot of bad instincts. Worse, I sometimes succumb to them. See if you identify with any of these examples of my faulty thinking.

I get hopeful too quickly.

I've thought of buying shares of the Gap (NYSE: GPS). Why? Well, the company, which once seemed to be firing on all cylinders, has fallen on hard times, culminating recently with the stepping down of its CEO and new stock price lows. I think back to the early 1990s, when shares of IBM had also fallen precipitously. At the time, I naively thought that IBM, with its powerful brand and all, was much more likely to get its act together than to go out of business, and it might make a good investment. I didn't ultimately invest in it, but it rose in value more than seven-fold over the following years.

This makes me wonder whether the Gap might also recover soundly. Of course, to be a responsible investor, I should go way beyond this initial association and dig deeper to identify the Gap's problems and its chances of overcoming them. I should evaluate the company's financial health, too (noting, for example, that it has much more long-term debt than cash on hand).

I'm overly influenced by the financial media.

This flaw is ironic, since we at The Motley Fool have long advocated being careful about where you get your advice, and have often pointed out problems with the traditional financial media. Still, when I read an article in a magazine detailing why a given company is attractive, I must admit that I frequently find myself wanting to invest in it. This happened just the other day, when I read about J. C. Penney (NYSE: JCP) in Kiplinger's.

The article explained how after much deterioration in its business, Penney is turning itself around. But the article still offered far from enough information on which to base any kind of investment decision. Before getting close to investing in any company, I should read and think a lot more -- and crunch some numbers, too.

I just did crunch a few numbers for Penney, and did find a bunch of promising signs. Inventory turnover has gone from 3.71 in 1999 to 4.11 in 2000 to 4.47 in 2001. That's good. Of course, inventory turnover for 2001 was around 5 for Sears (NYSE: S) and a whopping 7.8 for Wal-Mart (NYSE: WMT). (But then what about Wal-Mart isn't whopping?) I also ran across a Reuters story about J. C. Penney's latest earnings that quoted a Merrill Lynch analyst as saying: "It indicates a major turnaround.... In fact, I'm calling it possibly the turnaround of the decade." That was enough to get my heart racing again, but I calmed it down and remembered analysts can be far from objective evaluators of companies. For now I'll leave J. C. Penney be.

I forget how little I know.

I keep a watch list, with many companies on it that have caught my interest in past years (parts one and two of a special feature I wrote about my watch list). The other day I noticed data storage specialist EMC (NYSE: EMC) and saw that it's down some 92% from the $95-per-share price at which it first caught my fancy.

Again, a stupid instinct rears its ugly head: "Wow -- down 92%! It's still a good company, I'd think. Maybe I should snap up some shares, for the inevitable rebound." This thinking is faulty in several respects:

  • First, the stock is down to around $7 per share. That does not mean it can't or won't drop further, to $5, $2, $0.75, etc. It may indeed never trade as low as $7 again, but it's wrong to think that any company has ever definitely hit bottom.

  • Next, even at $7 per share, the company may still be overvalued. To consider what is arguably the coarsest approximation of its value, its market cap is north of $16 billion. That's still pretty big, roughly twice the value of Boeing (NYSE: BA) and not far from that of Sears. (They're far from apples and apples, but consider that EMC took in $7 billion in sales in 2001, vs. $41 billion for Sears. Sears earned a net profit of $735 million in 2001, vs. a loss of $508 million for EMC.) Does EMC's current value represent a fair price? Perhaps, but it certainly bears further investigation.

  • The biggest problem, though, is my ignorance. I'm no expert on data storage. I can read the company's website and various press releases and news stories, but unless I invest time to learn a lot about this industry, I'll never really understand EMC's place in the data storage world, how its competitors are doing, what technical issues and challenges the companies face, which firms offer better technology and support, which firms are best positioned to increase their market share, etc. (I do understand statements I run across such as this one, though: "The company's bread and butter has been selling refrigerator-sized machines to the world's largest corporations.")

It's vital in investing to understand the businesses that your companies are in. I haven't always done this, and it's hurt me on many occasions. If I were to invest in EMC, I might do well in the long run, but maybe not. And if not, I may never understand why. That's a problem.

I don't take to heart enough principles in which I believe.

This regrettable instinct is that, although I know better, I don't always practice what I preach.

For example, although I've long wanted to sell some (but not all) of my AOL Time Warner (NYSE: AOL) shares to generate some cash that I anticipate needing, I've kept stalling as the stock has just kept falling. For a long time. When it was at $32, I told myself I'd sell at $36. When it was at $36, I said I'd sell at $40. When it dropped to $26, I said I'd wait until it hit $30. When it dropped to $18, I shook my head and couldn't bring myself to sell for so much less than I could have gotten earlier. Stupid, stupid, stupid.

The right thing to do would have been to sell as soon as I lost faith in the company or realized I needed some cash or found a much more compelling investment.

A key but often overlooked investing concept is that, instead of my waiting to earn, say, 20% more on AOL, I could have moved that money into an investment I felt was better positioned for growth, and earned my 20% (or more!) in that stock. After all, does it really matter whether I make my profit on AOL or some other stock? Isn't it smarter to put your hard-earned money in those investments that stand the greatest chance of appreciating? Your money should always be parked in your best ideas, not sitting in less-good ideas, waiting to eventually be moved to your best ideas.

This flaw is so pervasive for me that I'll cover it again with another example. I own just a few shares of WebMD (Nasdaq: HLTH). They've dropped about 90% in value since I bought them and are now worth only enough to buy a VCR with. Still, I'm hanging on. Why? I suppose since there's such a paltry sum left, I feel it's not worth thinking about it too much. But while those shares of WebMD might not change too much in value, if I moved that pittance into a company that I understood better and had higher expectations of, I'd likely do better. Maybe one day I could sell them and buy a washing machine.

I own too many companies.

Here's one last example of me not walking the talk. I often find myself looking at lots of companies, thinking about buying into some, when I already have too many companies in my portfolio. I own nearly 25 companies right now. I'd once whittled that down to around 12-15, which was ideal for me, since I can't possibly really keep up with more than that many companies. Also, by concentrating my funds on just my best ideas, I'll give them a greater chance of boosting my net worth.

I think those are enough confessions for me for now. What are some bad instincts that you have? I invite you to drop by our Fool on the Hill discussion board to share your thoughts or to see what others are saying. (Free trials are available if you haven't signed up for our boards.) Learn and benefit from some of my failings (or those of others) -- please!

Another bad instinct of Selena's is occasionally ordering a medium or large ice cream cone at Dairy Queen, when a small one would do just fine. She owns shares of AOL Time Warner and Healtheon. To see Selena's complete stock holdings, view her profile. The Motley Fool is Fools writing for Fools