We’ve all been there. We’ve worked our fingers to the bone for all of the money we are wanting to invest – we place the trade and see the stock immediately go down… oh no – I better get that out quickly before it drops further! We let emotion cloud our judgement and it’s to the detriment of our investing! So how do we stop letting emotion get in the way?
Research. The more research you do, the more reassurance you will have that your investment will grow in the longer term. Part of the emotional attachment is the uncertainty of where the stock will go. By doing solid research, you can be sure that the stock will grow in the long term so emotion can be left at the door when short-term volatility rears its ugly head.
As we know, emotion plays a huge part in how well our investments perform but what exactly makes us feel the emotion towards this arbitrary number on the screen and exactly what research can be done to curb this – let’s take a look.
Ps- I learnt all of this from ‘The Intelligent Investor’ – Benjamin Graham, it’s one of the books on my Recommended Books list so if you want to dig a little deeper into this, I’d definitely recommend taking a peek!
Why do we get emotional?
There are 2 reasons we feel emotion during investing, which we actually touched upon in the first section of the post. Put to put a finer point on these emotions, they are:
- Fear; and
- Greed.
Fear
You’re probably wondering what you’ve got to fear when it comes to investing and the answer is, not much.
But to a less experienced investor, it may seem like the other way round and actually you have EVERYTHING to fear.
The reason we feel fear is because we are afraid to take the risk to invest our hard earned money into this mystical stock market where dreams can be made or crushed. Ultimately, we’re worried that our stock will go down and we’ll have wasted our money (I’ve actually written a post on Investments That Don’t Lose You Money which you might be interested in).
Greed
This is more of a controversial one as people don’t like to think of themselves as greedy – the emotion has a few negative connotations but it doesn’t make you a bad person… just a bad investor 😉
Greed comes into play when we see our stocks fly – we think ‘oh my god, this is really happening – I’m going to be rich!’, not understanding exactly WHY the stock is rising or how temporary this jump actually is.
We decide to hold on for dear life and ‘ride the wave’ to get the most out of our investments, not realising that the fear of losing money and the greed when we end up making money is going to hurt us in the end.
How do I research?
We’ve discussed briefly how to avoid letting emotions ruin your investment prospects and we’ve gone into exactly what emotions are at play here – but how exactly do we research to ensure we can use this to fight off those unjustified ‘hold’ or ‘sell’ urges at the wrong times.
Well, the best way to see if a stock is a good investment is to take a ‘Value Investing’ approach. This is the one taken by Warren Buffet and discussed by Benjamin Graham in ‘The Intelligent Investor’ (Recommended Book).
Getting Started With Value Investing
First of all, we want to understand exactly WHAT value investing is.
Value investing is where you find shares that have been undervalued by the market and buy into them at the point they are undervalued. The goal here is to hold them for the longer-term as they will eventually surpass their true valuation when the market corrects itself.
How to determine if a stock is undervalued
In order for something to be undervalued, you have to compare the current stock price (which you’ll be buying in at) and the ‘Net Book Value’ of the stock based on the company’s latest accounts.
To find the ‘Net Book Value’ of the stock, you need to find the company’s Balance Sheet (also called a ‘Statement of Financial Position) and find the value of their ‘Net Assets’. You then divide this by the amount of shares issued by the company and this is the ‘correct’ or ‘reasonable’ price of the share.
Ps- you can find the latest company accounts from a few places:
- The company’s website;
- Your investment platform; and
- Companies House (UK only).
Let’s take an example of Royal Mail – here’s a screenshot of their net assets from their company accounts:
Here you can see that the Net Assets equals £4,805,000,000 (£4.805 billion) – this is what the business would be worth if it were completely stripped down into cash and their debts were all paid off. This is the net book value (NBV) of the company.
Now we need to divide the NBV by the total number of shares in circulation at this point in time. To find this number, we just go to the ‘Company Info’ sheet on the investment platform as they’ve done this work for us:
So we have 1 billion shares issued and the total value of the company is £4.805 billion – we therefore know that the share price SHOULD ideally be £4.805 per share.
Now looking at the share price – I can see that the shares are currently selling for 588p (or £5.88). So we’d need it to drop below the £4.805 mark before we’d consider this as undervalued.
Hopefully that makes sense?
Summary
To nicely round off this article – here’s what we should now know in order to stop emotions getting in the way of our investing:
- The emotions getting in the way are namely Fear & Greed;
- Fear comes into play with the prospect of losing the money we worked hard to earn;
- Greed comes into play when we see shares soar and we try to ride it all the way to the top without looking into why it’s rising so much; and
- We can utilise value investing to identify low stocks so that we can gain comfort that regardless of how the stocks move in the short term, we are 100% they will gain in the long term.