In this Information Age, there are many distractions that can lead long-term investors to buy or sell stocks in a panic, which incurs taxes and commissions and lowers their overall returns. The three "don'ts" of investing listed below will help you get focused on the big picture and worry less about the short-term ups and downs of the market.
Don't stare at the quotation screen
Twenty years ago you only knew your closing stock price for the previous day when you read your daily newspaper or phoned your broker to buy or sell shares. Now, thanks to the Internet, you can receive up-to-the-minute quotes on your shares, allowing you to fret all day long about every little price swing. This can provoke you to sell shares in a great company that could enhance your wealth over the long term.
For example, take the stock of fast-casual restaurant Chipotle Mexican Grill (CMG 0.06%), which climbed to nearly $450 in the early part of 2012 before disappointing earnings sparked a nearly 39% drop in the stock price from July to October of 2012. Witnessing such a drop can lead to panic-selling, most likely at a loss compounded by stock brokerage commissions. However, over the past year Chipotle Mexican Grill's revenue and free cash flow have increased 12% and 51%, respectively, leading to a 24% return since the beginning of 2012. This underperforms the market, but the company is still in an expansion phase, and it plans to open 165 to 180 stores in 2013. Further, the growing popularity of healthful food will help drive the company's top- and bottom-line growth. Long-term investors who sold out last year would have missed out on the rebound and any future gains that may await.
CMG Total Return Price data by YCharts.
Don't worry about daily headlines
Similar to watching stock quotes is watching the daily headlines. Headlines can also distract you from the big picture. The Dow Jones Industrial Average (^DJI +0.75%) declined 5% in August due to various headlines ranging from the Federal Reserve's "tapering" of economic stimulus to the United States' involvement in the Syrian civil war.
Investors who panicked during the decline in August missed out on the market rebound occurring in September. Markets will wax and wane, but the key to weathering these storms lies in staying invested. Moving in and out costs you in terms of opportunity, taxes, and commissions.
Don't forget that you're studying businesses
When staring at Internet headlines -- especially the stock quote screen -- you forget that a dynamic business lies behind those numbers and graphs. You must look for catalysts that will propel your business forward, such as a product immune to obsolescence, high barriers to entry keeping would-be competitors at bay, and a forward-looking perspective.
For example, beverage and snack conglomerate PepsiCo (PEP 0.48%) sells products such as orange juice, bottled water, snacks, and healthful food. Unlike computers, these products will never go out of style. Pepsi's bottling and distribution infrastructure keeps new competitors from moving into its territory. Its Lay's snack foods and Quaker segments set themselves apart from rival Coca-Cola, which mostly sells beverages. When factoring out acquisitions and divestitures, PepsiCo's snacks segment grew volume 3% in its most recent quarter, while its beverage segment only increased volume 1.5%. Companies focused on soda face an increasingly dismal future as increased health awareness stigmatizes its consumption. PepsiCo's future is in innovating nutritious snacks and selling healthier non-sparkling beverages such as juice and bottled water.
On the whole, when researching a company for investment, it pays to keep your nose glued to the investor relations website of your target company, where you can find information in their SEC filings about financials and competitive positions. Watching the daily movements of your companies' stocks and news headlines in general invokes a panicked, short-term mentality that will result in knee-jerk transactions, costing you in terms of commission, taxes, and opportunity. Instead, focus on businesses that generate cash flow that will translate into dividends and capital gains for the long term.
