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Getting into the stock market can come with all sorts of opportunities and pitfalls – some more obvious than others. Before someone makes a move to start buying shares, I think it is helpful to learn about some common beginners’ mistakes so they can try to avoid them.
1. Confusing a good business with a good investment
Looking at a company with a strong business does not necessarily mean that it will make for a good investment. That depends on the price one pays for its shares.
2. Thinking that a share must be worth at least as much as its underlying assets
Another form of confusing an investment with the underlying business can be when it comes to what are known as net assets.
When people start buying shares they sometimes think that a company with more cash on its balance sheet than its current market capitalisation (the sum total of all its outstanding shares) is cheap (which may be true) and that therefore the share price must go up (which is not true).
A share can trade below its net asset value for years or even decades. Meanwhile, the company may burn through those assets.
3. Sticking only to your favourite idea
When billionaire investor Warren Buffett decided to start buying shares as a schoolboy, he invested in only one company.
New and experienced investors alike can fall in love with a single investment idea so much that they put all their available money into it. But even a brilliant company can meet unforeseen challenges that are outside its control.
Smart investors therefore diversify their portfolio from day one, even on a limited budget.
4. Buying into businesses you do not understand
Today there are exciting-seeming newish businesses on the stock market with vague business plans but impressive sales pitches and a promising share chart.
That will almost certainly be the case a year or decade from now. The stock market contains some brilliant opportunities — but also some dogs.
Putting money into a business you do not understand is not investing – it is speculation. That can turn out to be a costly mistake.
5. Rushing things
The prospect of great opportunities that may not stick around can lead people to start buying shares in a hurry, before they have properly done their homework. Again, that can be an expensive mistake.
As a long-term investor, I think rushing things can be a problem not only in selecting shares to buy but also once owning them.
I prefer a long-term approach to investment. As an example, consider my stake in Google parent Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL).
Like a lot of companies at the moment, there is a big question mark over what AI may mean for the business. It could see demand for Google’s search capabilities shrink dramatically.
As last week’s quarterly results underlined, Alphabet’s push into AI is also running up a sizeable capital expenditure bill. That poses a threat to profit margins.
But while the short-term picture is uncertain, stepping back and looking to the long term, I remain confident in the company’s prospects.
Alphabet has deep technological expertise, a massive customer base that in many cases have a lot of their data sitting on the firm’s servers, and a proven business model.
