A couple weeks ago, I wrote a post about Value Investing and the value, no pun intended, in this type of investing. Today we want to go over a few risks with Value Investing and how to combat them. As with any type of investing, there is ALWAYS a risk that you could lose money. And not just some, but all of your money. But don’t let that scare you. Because if you do your homework and understand the risks, you can put yourself in a very good position to grow a pretty strong stock portfolio.
The doing your homework part is pretty freakin’ important!!! While doing your homework, keep these risks in mind:
1. Know the Numbers
When you’re looking at financial statements, make sure you’re using the latest figures. It’s pretty bad when you make an investment in stocks based upon numbers from two quarters ago. A lot can happen in two quarters so you need to make sure you are working with the latest numbers.
Many people will read the footnotes of the Form 10-K or Form 10-Q to understand the company’s accounting practices. If these footnotes are not clearly understood, it may be best to leave this stock be.
2. Extraordinary Items
Sometimes there are extraordinary gains or extraordinary losses that show up on a company’s income statement. These are exceptions that don’t typically happen and shouldn’t be used when determining a company’s future performance. Things like lawsuits or natural disasters are exceptions and can make things seem worse than they are. You can probably get a better sense of the company’s future performance if you exclude these extraordinary items.
3. Using Bad Ratios
There are a number of financial ratios that can be used in determing a company’s value. Since there isn’t just one way of determining these financial ratios, it’s possible you could be working from bad data. Be sure you understand the ratios you’re using to make your decisions. Or better yet, do the math yourself.
4. Paying Too Much
You need to build a Margin of Safety into all your investments. Look to purchase stocks for about two-thirds or less of their Intrinsic Value. If you use this approach, you reduce your risk of losing money, even when the company isn’t doing so well. Don’t start off your investing with paying too much. It’ll put you in the hole right out of the gate.
5. Failing to Diversify
Value Investors say that you can diversify your portfolio, even with a small amount of individual stocks, as long as you buy stocks that represent different industries and sectors of an economy. Look to diversify to minimize your risk.
6. Following Your Emotions
Never, never buy or sell stocks based on emotions. Try to detach yourself from the ownership and look at the numbers objectively each time in order to make sound decisions. Don’t let FOMO (Fear of Missing Out) or the Sunken Cost Fallacy lead you down the road of poor decisions.
Anytime you invest your money, you’re taking a risk. Some would call it gambling, but it isn’t gambling if you can make an educated, calculated assessment of the investment coupled with a true understanding of the risk you are taking on for the investment you want to make. Like anything in life, understanding risk is key. Don’t fall victim to these six risks that have killed investments for many people before you. Be aware of them, plan for them, and avoid them. Investing does involve risk. But how much risk depends on you!!!