Investment sayings can look like an easy shortcut to portfolio profits. But more often than not, they will end up costing you money.
Investment sayings: “You get what you pay for” is a worthwhile tidbit of investment advice if you understand how to apply it
The adage should come to mind whenever you come across a stock that seems extraordinarily low-priced. For example, suppose you find a stock with a P/E (per-share price-to-earnings) ratio of, say, 6.0, at a time when seemingly comparable stocks are selling at P/Es of 12.0 or 15.0.
The you-get-what-you-pay-for rule tells you there’s always a reason for an unusually low P/E—just as there is for an unusually high dividend yield.
With doubts about earnings, this lower price shows up in a below-average P/E ratio. (The P/E is lower than average because “P” is the numerator or upper figure in the ratio.)
With doubts about dividends, this lower price shows up in an above-average dividend yield. The formula for dividend yield is D(dividend) / P(stock price). The yield goes up because the P, or price, is depressed and it is the denominator or lower figure in the ratio.
In both cases, investors have reason to doubt the quality or sustainability of the company’s earnings or dividend. The reason may be good or bad. Either way, you get to buy a stock at what looks like a bargain. That is, you pay a lower price in relation to the stock’s earnings and dividends—lower than prices for comparable stocks.
However, when you come across an attractive stock with a low P/E or a high dividend yield, you need to do two things:
First, figure out why investors have doubts about the stock; second, decide if the reasons for these doubts make sense. Remember, stocks can go in and out of favour with investors for bad reasons as well as good ones.
So, to profit from “you get what you pay for,” you need to tack on six extra words: “…but only if you shop carefully.”
“Rising interest rates are bad for stocks” is one of the investment sayings we don’t agree with
One of the investment sayings we often hear is that “Rising interest rates are bad for stocks.” It’s easy to draw this conclusion from looking at a narrow slice of the historical record. You can find plenty of times when rates rose and stock prices fell. But you’ll also see long periods when stock prices and interest rates moved up together.
For example, interest rates moved up gradually from 1945 through 1969, during the great post-Second World War bull market in stocks.
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A gradual rise in interest rates over the next few years and following the pandemic would likely have negligible direct impact on stocks. Today, investors understand that interest rates are artificially depressed, and have been for years. They expect that rates will eventually move back up to more normal levels. They would take it as a confirmation that the economy is recovering, and central banks feel they need to keep nudging interest rates upward to counter inflation.
“Sell in May and go away” or hold steady? Some investment sayings don’t hold up to careful examination
This saying is based on the observation that, over the years, stock prices have often gone sideways or dropped between May and October. Some investors feel the sell-in-May rule is timely. If the market has been on a long upward trend, investors may see it as due for a setback.
The problem with this kind of analysis is that it fails to distinguish between causation and correlation. The pattern of falling stock prices between May and October may simply be a coincidence, like the pattern that may appear in a series of coin tosses or spins of a roulette wheel.
Many investors have guessed right about a coming trend at one time or another. Maybe they bought just prior to a big upswing, or sold in advance of a major slump. In the long run, however, these experiences may wind up costing them money. They may bet twice as heavily on the next trend they foresee, with more volatile stocks, only to discover their forecast was 100% wrong.
I’ve seen a number of vague warnings that sharp market downturns have followed sluggish periods. I’m sure that’s true. However, sharp market upturns have also followed other sluggish periods.
Even when seasonal tendencies seem clear in historical records, they can still disappear without warning, or reverse themselves. That’s why few investors have ever managed to make money with seasonal trading programs. I suspect that on the whole, investors have lost more money than they’ve made with that kind of trading.
You’ll never find a simple, fits-on-a-T-shirt rule for picking stocks or beating the market. That’s because the market responds to a variety of factors and influences, but it does so inconsistently. Each relevant factor matters a lot more in some years than others. That’s why we use a wide range of information to make investment decisions, and we consider the investment sayings we hear carefully.
What is the most controversial example of investment sayings you’ve heard that you completely disagree with?
Have you been led astray by following an investment saying or quote? What happened?
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