May 26, 20225 min read

The Biggest Stock Market Mistake Now

Many people will do idiotic things in the present market, and I thought I'd save you the time, energy, and, hopefully, the money from yourself and from making big mistakes. What are some of the biggest mistakes people might make?

The first thing, of course, is to chase losers.

There is not enough data for it to be a good strategy, just buying something because it's fallen. As you can see here, falls do not mean value, and I've drawn them at the time of recording. I've put the six-month declines on there - Netflix is down 73%, Etsy's down 65, and PayPal is down 61.

There will be time to do a deal in some of these companies, but it'll depend on valuation, which is the share price relative to another metric, such as its assets or value, profitability, and cash flow.

Momentum will be another factor to look at. Cash flow's always going to be important, certainly for survival, because small changes in cash flow have a massive impact on the other two main parts of a business's accounts, its balance sheet and, most importantly, its profit and loss account. We don't want to be trying to catch the proverbial falling knife.

Overall market direction, while there are obvious signs of headwinds, i.e., falling markets, you might not want to get into companies that have already been on a downward trajectory. Overall growth, revenue growth, and we'll want ones with lower volatility, particularly in a falling market or a market that in itself is already volatile.

So, big mistake, just chasing something because it's already fallen, albeit their great names. I mean, Adobe, a name for the ages, Walt Disney, great name, PayPal, I own some, great name. But would I get into it right today?

No, because it doesn't tick all those boxes right now, so we keep monitoring it every week until they start getting in our crosshairs; everything's perfect, then we lock on and close the deal.

What will special situations look like? Will there be some special situations?

Of course, some of these companies will fall, but I'll really be looking for those that will give me a return. If they go back to the peak, they've had of 100%, and that's likely to happen, based on the fundamentals of the company, within the next two years.

So you can imagine, I'm looking for a deal that is a screaming buy, not just, "You might make 25%, 20% if you're lucky." The environment's too difficult for me only to be satisfied with such a low return as 20, 25%. I need a deal that is likely to make 100% because I still hit my benchmarks even if they fell somewhat.

I want companies with volatility below 20%. In a high inflationary environment, low volatility companies tend to do better, but also because I don't want volatility when the markets are falling. I want it when the markets are rising.

Valuation, I've already mentioned. Growth and cash flow. I particularly like the cash return on capital invested metric. Now, when all of those factors are met, and probably a few others, momentum, for instance, overall market direction, and so on, there'll be some special situations I'll get into. I have no problems holding cash until I get a great deal.

Chasing momentum.

Another mistake. You go to the other end of the table, saying, "Wow, these ones are just shooting up. Where's my 81%? Where's my 54%? Where's my 48%," and so on.

Well, the problem here is you want your dopamine hit. You want to say things like, "I want the gains I had a year ago, two years ago, three years ago." Or you might say something like, "But inflation means I have to take risks. I have to be in the market. I could take all of these."

The problem is when you look at these momentum plays, the ones who have been doing well. Do you know if they're overvalued? Have you looked at the price-earnings ratio, price to book ratio, price to free cash flow, or even done a discount cash flow valuation? Are they growing? Are they in sectors that tend to be better in inflation environments? Or are you just buying in a fast-falling market? Maybe all the gains, therefore, have already been locked in. Simply looking at the gains over the last six months will not tell you enough whether or not this is a great deal. Okay?

My rules

That's the S&P 500, where I think it will drop at least a 0.2, if not a 0.3. Three is 50% off its highs. Initially, in January, if you told me, I would've said, "No, I don't think that's going to happen." But then again, I'm not in the guessing gambling business. I keep reevaluating, taking on more information. I never close my mind to more information. So my way of doing things now the strategy is to tick value, growth, and income.

If there are companies that tick all those boxes. And tactically, when the market's falling as it is now, to wait patiently for outstanding deals and focus on what the data shows do well at this time, which is on top of that strategy of valuation, growth, income, really focusing on undervaluation.

Price-earnings and peg and give more weight to those right now. Lower volatility gives more weight to those. A higher market cap gives more weight to those. Look at the monthly momentum chart. Does it suggest rising momentum? I, as always, hold for 12 months with a 25% trailing stop as a general rule. I might tweak some of those things, but as a general rule, at least I know what my worst-case scenario is when I get into it.

Why 12-month holdings? You've just seen in this market; it should have taught you a lesson. You don't buy and hold forever. The world changes too quickly for that. So 12 months or 25% trailing stop losses hit beforehand.

Put it another way with the strategy where there will be a slow recovery, medium, fast, or mixed.

I think the greater probability is somewhere between slow and a mixed recovery, which means I've got to be flexible and agile in terms of what I pick. I can't simply say, "Oh, I will just keep doing everything that I've always been doing," other than the fact that strategically value growth thinking, but tactically, I've got to be agile. I've got to say, "Well, wait a minute. We now want lower volatility companies, which are undervalued because we're in a very high inflationary environment."

Did I see that two years ago? No, we did suspect inflation was going to hit at some point. I didn't know it was going to be today. I didn't know today was the day or this year was the year. And in terms of the next steps, I'll probably hold more cash. That's what it means when you've got a mixed recovery. And be very, very selective and picky with a few special situations.

I hope you found that helpful. Depending on where you're reading this, follow, like. Suppose you're part of my Great Investments program. In that case, you don't need to do any of those things because you're going to get the insights into the stocks that I like at any given moment and which the data, data, data, data shows meet our very, very stringent criteria at the moment.

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