We spend a lot of time here at the Motley Fool looking for home run stocks. There's nothing better than being able to say "I got in on Microsoft (Nasdaq: MSFT) in the early 1990s" or "I bought Wal-Mart (NYSE: WMT) back when Kmart was relevant."
That said, it's just as important to avoid strikeouts as it is to hit home runs. Most successful investors will tell you they regret their strikeouts more than they bask in their home runs.
With this in mind, let me walk you through three investing strikeouts that will sap your returns -- and how to avoid them.
Don't go down swinging
In baseball, there are few things more embarrassing than taking a huge rip at a pitch only to completely miss the ball.
For investors, this happens when we find a stock that we admire so much we fall in love with the story -- and ignore the cold, rational judgments we're supposed to make on cash flows, debt loads, and upside potential. We check its stock price 10 times a day (just to say "hi"), we introduce it to our friends (you guys will love it!), and we turn a blind eye to its warning signs (those margins will recover!).
You know what happens next. Too often the stock you thought was "the next Microsoft" turns out to be "the next MicroStrategy" Hint: It once sold for $3,000/share (split-and-dividend adjusted) during the Internet bubble but is now down to double digits.
Take a walk
There's no glory in taking a walk. Yet, as the cliche says, the end result is as good as a hit.
Many of us invest as if there are extra returns awarded for level of difficulty. Just because we did hours of research on a sexy Chinese small cap doesn't mean it's a better option than an emerging markets index fund or ETF. Sometimes "turnaround" stocks that are down 80% lose that last 20% as well. And sometimes a cigar butt is best left unsmoked.
McDonald's (NYSE: MCD), Johnson & Johnson (NYSE: JNJ), and Altria (NYSE: MO) trade for forward P/E's of 13, 12, and 10, respectively. The question you have to ask yourself is whether the upside on a potential strikeout is worth passing up one of these walks.
The backwards "K"
The first two strikeouts were errors of commission. Not swinging at a good pitch, on the other hand, is an error of omission.
Let me illustrate with my own misery.
Last year, right around the market bottom, I noticed something. Due to the tight credit conditions, companies with a lot of debt were priced at near-death prices. The risks were real, but the potential for 100% losses were more than offset by the potential for gains that were much higher than 100%.
My plan was to buy small positions in a portfolio of beaten-down companies. Think casino stocks like MGM (NYSE: MGM) and bank stocks like Bank of America (NYSE: BAC). I figured the winners would more than make up for the losers.
I bored my officemates each day with talk of my grand plans. But that's all I did -- talk. I kept putting off due diligence of my candidates for another day. You know the rest of the story -- the market rapidly recovered, led by the kinds of stocks I was looking at.
Now, I steadily added new money to my investments the whole time, but I missed out on this big opportunity. I struck out looking at multi-baggers.
Keep the home runs, ditch the strikeouts
As you search for home runs, remember these three principles to avoid the return-crippling strikeouts:
- Keep your emotions in check
- Don't ignore the easy gains the market offers
- Take timely action
If you'd like more help honing your investing skills, the Motley Fool's co-founders, Tom and David Gardner, share an investing lesson and two stock picks each month in their Motley Fool Stock Advisor service. They've had their share of both home runs and strikeouts, but they've done well enough to beat the market by an average of more than 50 percentage points per pick. Click here to try it free for 30 days. There's no obligation to subscribe.
Anand Chokkavelu owns shares of McDonald's, Microsoft, and Altria. Microsoft and Wal-Mart are Motley Fool Inside Value picks. Johnson & Johnson is an Income Investor choice. Motley Fool Options has recommended buying calls on Johnson & Johnson and diagonal calls on Microsoft. The Fool has a disclosure policy.
