5 Investing Myths That Will Destroy Your Portfolio Growth

IMPORTANT: Please read the disclaimer before continuing.

Recently, I have been performing focus groups to understand what differentiates high performing investors from other investors. I wanted to understand the belief systems that helped them create their outstanding portfolio results.

And I came to realise, that to be able to become a high performing investor, we need to first tackle the inherent bias and beliefs that we have in our system that are actually preventing us from excelling as an investor.

Note: This article is meant to be re-read multiple times for the best results!

Let’s start!

Myth #1: “If it’s gone this high already, how can it possibly go higher?”

For any stock data provider, it provides 52-weeks high and 52-weeks low for companies.

And with that, many investors will have the notion that “If it’s gone this high already, how can it possibly go higher?”.

When I just started investing, I completely agreed with this statement. I formed an aversion towards any stocks at a 52-weeks high because I was taught that it has a lot of “risk”.

I then went to search for companies that are hitting 52-weeks low, thinking I could find good businesses selling at cheap valuations.

And I was dumbfounded. All I got was a group of struggling businesses.

How is that possible?

Businesses who are at their 52 weeks low tend to be companies that are not doing well. when these businesses hit their 52-weeks low, they continued creating new 52-weeks lows as their businesses deteriorated further.

That was when I switched my mindset around. I looked for companies with 52-weeks high instead.

When I looked at companies like Adobe, Alphabet, Apple, Salesforce.com, they kept hitting 52-weeks high. These are what I termed as winning companies. They kept winning by growing their revenues consistently. Despite the optically expensive share price, some of their valuations still made sense because the businesses had grown.

As such, I no longer choose companies with 52-weeks low. Instead, I focus all my time to search for companies hitting 52-weeks high because it is a sign that they are healthy and winning in their industry. From there, I work out their valuation and determine their intrinsic value.

Never let a high price stop you from researching an excellent company.

Myth #2: A stock that is selling at $1 is very cheap!

“Don’t buy a stock that is selling above $100! It is hard for you to double your money! Buy stocks that are selling as cheap as possible! Buy stocks with share prices of $0.50 or lower.”

Have you heard about this statement before?

While it is natural for people to think that way, we have to consider this statement by Buffett:

“Price is what you pay, and value is what you get”.

Let’s use an example:
There are two apples. One of them is selling for $1 and another one is selling for $0.50. Which one would you buy? You will likely go for the $0.50.

But what if I informed you that the apple that cost $0.50 is fully rotten inside whereas the $1 apple is Japan’s best Honey Apple? You would definitely change your answer.

As such, the share price tells us nothing much unless we compare it with something. Some examples are earnings, revenue or book value of the company.

RELATED: What is Price to Book Ratio?

Let’s compare two companies using Price to Book (P/B) ratio –

Did you know that Berkshire Hathaway, which has a share price of US$294,496, trades at a P/B of 1.27x? On the other hand, Physicians Realty Trust, which has a share price of $18 trades at a P/B of 1.38x.

Look, Berkshire Hathaway’s share price is $294,496 but it is cheaper than Physician Realty Trust on the Price-to-Book basis.

How is that possible?

Berkshire Hathaway has a high book value. This means that for every dollar of asset in Berkshire Hathaway, investors are paying 1.27 times of it as compared to 1.38x for Physician Realty Trust.

Back to the same saying, price is what you pay, value is what you get.

In short, don’t just look at the share price, look at the valuations as well. I seldom refer to the share price now, and opt to use valuations to guide my buying/selling decisions instead.

Myth #3: “You should buy stocks with a low P/E ratio”

For definition of P/E ratio, click here.

Most of us would love to buy companies with a low P/E ratio because it signifies that we are buying it at a good valuation. Buying a stock at a P/E ratio of 10x means that for every $1 of earnings, you are paying ten times in share price.

For example, when you pay $10 million for a company that earns $1 million, the valuation you pay is 10x.

But truthfully speaking, I have not found a good company with a low P/E ratio.

In fact, I have become very skeptical of companies with a low P/E ratio.

Low P/E ratio companies tend to have severe problems such as high debt, stagnant revenues or decreasing earnings. Although there are exception cases where it is a good company trading at low P/E ratio, those are few and far between.

When you look at General Motors, it is trading at a P/E of 7x. Does it look cheap to you? It’s cheap for a reason.

On 29 July 2020, General Motors reported a sharp decline in their 2020 second quarter results. Their earnings fell from US $3 billion to negative $0.5 billion (page 6).

When the earnings continue to decline, inevitably, the P/E ratio would shoot up.

In the most extreme cases where the earnings keep falling, what is deemed as a cheap P/E ratio could be very expensive too.

This is why, as a starting point, looking at P/E ratio is often a wrong move for any investor. One should spend time understanding the business model and growth trajectory of the earnings instead.

Myth #4: “When (stock price) rebounds back to $X, I will sell”

If the price of a stock that you’ve purchased is falling drastically and you already know that it’s time to get rid of it… how often do we have this mindset of wanting to sell the stock ONLY when it rebounds back to your original purchase price?

It’s called price anchoring because who nobody likes recognising losses. This kind of cognitive bias is extremely dangerous.

Hope doesn’t work well with facts.

When a company is showing warning signs such as lower profits, lower return on equity, it is a clear sign that the business value has dropped. For one to hope for the share price go back up ONE DAY, the possibilities are razor slim.

By holding on, you’re damaging your portfolio further.

Remember this saying? Time is a friend of a wonderful business and an enemy of a terrible business.

How do we make the mental switch?

I want to share something powerful with you.

You don’t have to make back your losses from the stock that is giving you losses. You can take your money out and invest it in a high-quality growth company instead.

Some investors hold on to their loss-making stocks for years as there is some sentimental value. However, this is a surefire way to maintain your losses.

My perspective is that being emotional with our stocks prevents us from achieving more returns for our portfolio. We must let facts guide us, not our emotions. When the facts change, we have to be decisive and not be chained to any psychological effects of our past decisions.

Myth #5: “I should always hold a position with high % of returns”

As investors, it’s normal for us to feel comfortable holding a position that’s currently sitting on a high % returns. We might even feel uncomfortable buying stocks that are potentially better.

That’s a false sense of security and a psychological trap.

It’s ironic if we deem holding a stock with higher existing portfolio returns safer because we think there is a “cushion” of safety.

In a scenario where a business doesn’t perform up to expectations, we may even feel that it’s okay because we got “gains” sitting on it.

The truth is that any gains can be eroded over time.

What we should focus on is total portfolio returns and every best idea out there, not on any particular crown glory.

Every day, our capital is exposed to multiple opportunities to grow, and so it’s our duty to allocate it wisely to the best opportunities out there. A good question is “if I had to restart this position from zero, would I buy at today’s price?” If the answer is no, then why would you hold it?

Every day a position is in my portfolio, it’s saying I’m buying the business and valuations today. Don’t fall into your own trap, always focus on facts to create good performance.

Conclusions

My goal for all my readers is to create world-class investment returns to compound your wealth more every year. It is also my wish for you to achieve your financial freedom earlier than your own personal timeline.

For that to happen, we need to unlearn some myths which may appear logical at first but are actually stopping you from growing your money.

While it may be difficult to embrace a new way of thinking, it is something that is necessary to evolve into a better investor.

Ultimately, a stock could go up by 10x but not all investors will gain 10x. Different investors will have different results based on their own behaviors. As long as we keep our rationality about our decisions over our portfolios, we should do well for the foreseeable future.