I have tried hard to develop a strategy for investing. There is a process I go through when deciding which companies to buy and when. This strategy has worked well for me in the past. I became more confident, and as a result, less cautious. I recently received a wake-up call after breaking many of my own established rules (I purposely am not mentioning the company by name because I feel it would detract from the focus of the article).
- I did not check recent analyst earnings expectations.
- I did not take into account major court rulings that would significantly affect the company.
- I tried to catch a falling knife.
- I got greedy and fearful of missing a profit.
- I mixed trading with investing.
Always check for declining earnings expectations
Normally, when I notice a company has been beaten up by the market, I look for reasons why. The first thing I look for is slashed earnings or revenue guidance.
I did not bother to look at significant reductions in earnings expectations by The Street. While reduced earnings expectations often create exaggerated fears, presenting investors with an opportunity for discounted prices, the fact that I did not remember to look is inexcusable.
Always check for significant legislation that could affect the company
This company is directly affected by Obamacare. I did not consider what the repercussions would be, should Obamacare be upheld or revoked. This is not simply a small piece of news or legislation restricted to a small part of the company. This is a Supreme Court decision with significant ramifications for the company and the market as a whole. Essentially, investing right before such a monumental case was gambling.
Wait for a falling knife to hit bottom before getting in
As is clearly visible from the chart, it is a falling knife, with uncertainty regarding its bottom. It is best to stay on the sidelines until the price stabilizes. Buying at any point in this decline is creating a scenario of significant reduction in capital gains in the medium-term. For those who truly believe in a company that has fallen sharply and are committed to the long-term, buying a full position is still somewhat reckless. A small marker allows for dollar-cost averaging, and if the stock does a sudden reversal at least there will be a small position with gains.
When emotions are clouding judgment, it is best to take a break
People who control their emotions at all times are rare. Most investors continuously work on staying level-headed and not letting the ebb and flow of the market influence their trading decisions. However, no one is perfect, and we all go through periods of less focus and emotional difficulty. When fear or greed start to creep their way in, it is best to take a step back, regain composure and reinforce your strategies by reading investment books and going over past trades. When you feel refreshed and focused, it is time to re-enter the arena.
Juggling trading and investing can lead to a blurring of philosophies
Trading and investing are two different beasts, requiring two very different strategies. Trading focuses on the short-term and requires disciplined stops and constant monitoring. It is much more susceptible to emotions and swings. Investing is the opposite.
I began trading a few years ago and achieved moderate success. However, lately I have noticed my trading strategies creeping into investing. I thought I could keep my trading philosophy separate from my investing philosophy, but I see that it is very difficult for me to do so. I have decided to cut back on trading so I can focus clearly on investing.
Let us look at an example of doing things right with one of my favorite companies, General Mills (GIS).
Earnings expectations for the current year are down two cents. The stock declined 7% over the last six months, but this is not necessarily due to slightly reduced expectations.
There is no significant legislation affecting GIS at this time. General Mills' major concern is the price of wheat and corn. Rising commodity costs affect GIS and have since its inception. They have demonstrated the ability to adapt to price changes and continue to produce earnings increases.
No falling knife here, only a beautiful chart showing continuous growth.
General Mills is one of the most peaceful companies to own. It does not require constant monitoring, has a beta of 0.5 and a dividend of 3.5%. Reading the 10-K cover to cover, looking at past fundamentals and compound annual growths and picking a conservative entry price is a successful recipe for income oriented investing.
I believe I will eventually come out on top with my investment, but that does not excuse poor judgment. I am writing about my bad investment decision for everyone to see as a policy for others to avoid, but also as a reminder to myself. Before I make future investments, I will come back to this article to refresh my memory.