3 silly mistakes a beginner should avoid.

3 silly mistakes a beginner should avoid.

Hi there,

After interacting with some beginners, I found 3 very silly mistakes that’s so common. So, i thought i should write about that in this article, with the help of an example.

– You buy shares in company ‘x’ of IT sector. The shares move up and you get a decent profit. From that moment, you are tempted to look more deals like that., preferably from the IT sector- since you get a feeling the IT sector is a sure bet !

Not only that, in the process of trying to find such deals, you tend to overlook other investment opportunities that come your way – a new mutual fund offer or a low  rate in gold ETF or an opportunity to lock in a  debt fund that’s available at a higher rate of interest.

• This is the first point – as long as your investment remains in a few stocks or markets, you may be missing on other opportunities. It’s important to have an overall view of the economy and financial markets regularly- and not just stock market alone.Beginners tend to concentrate on stocks alone and in the process, they forget to take note of what’s going around in the financial world. For example – in 2010-11, it was gold that out performed all other asset classes. Those who had an overall knowledge about financial markets would have invested a part of their funds in gold.

Continuing the above example – let us assume that the buy price of that IT stock was Rs 150 and you sold it for Rs 225 in one month, thereby making a gross profit of Rs 75 per share. You made a killing on that stock. Every time that stock drops to Rs 150, even if it’s a year or two later, you’ll be tempted to buy that stock based on the previous experience. That ‘Rs 150’ remains in your memory as a sweet spot to buy. You tend to forget the fact that financial fundamentals of the company might have changed by then.

• So, that’s my second point – financial fundamentals of a company keep changing. That’s the reason why result announcements create such hype in the stock markets. It’s important to keep track of the fundamentals of the company every quarter. Do not buy a share just because it came back to the previous levels. This time, may be, there’s some problem with the fundamentals.

Let’s continue our story – after valuating some IT companies including the stock you previously owned, you have now short listed 2 companies – one trades at Rs 200 and the other trades at Rs 600. A common belief of beginners is that Rs 200 stock is 3 times cheaper than a Rs 600 stock. That’s wrong. For example, the company that trades at Rs 200 may have 6 million shares while the other one that trades at Rs 600 may have only 2 million shares. So the market capitalization of the two companies is the same. So the solution to this is in finding out the P/E of the stocks. The price of the stock is divided by the earnings per share and that tells you which company is more expensive. A stock that has a P/E of 20 is definitely priced lower than a stock that has a P/E of say, 65.

• That brings us to our 3^rd point – price per share is not the criteria to decide whether a stock is cheap or expensive. You need the P/E of the stocks.

From my interaction with freshers, these are 3 of the most common mistakes that they commit.

Bye for now!