The following article originally appeared on DivGro on 2017-07-9.
It’s hard to imagine that it has been five years since I started investing and bought my first stock, Netflix (NFLX). When I look back and think about the mistakes, lessons, and experiences over these years, I am quite humbled.
Investing is something special and, somehow, it makes life more profound and enjoyable.
There are things I wish I would have learned earlier. Back in 2012, NFLX was a growing company and I quickly realized a gain of about 70%. I thought I was the king and that making money in the stock market was so easy!
Because of my success with NFLX, I wanted to find other stocks to earn money with.
Before buying another stock, though, I decided to learn more about investing so that I could become even better at it. I googled around and everyone seemed to recommend The Intelligent Investor by Benjamin Graham.
So I picked up the book at the library and started reading. I suppose I read about 20-50 pages before returning the book to the library. If you asked me at the time for a three-word review of the book, I probably would have said something like: Alienated! Utterly Boring.
One would think that reading such a highly recommended book would have a positive impact on a 19-year-old. Instead, I spend several years speculating on the stock market, foolishly chasing binary bets with little or no margin of safety.
The problem was that I started with a book that was too advanced for me at the time. It made me dislike fundamental analysis for about 3 years and I went straight into the world of technical analysis and doing speculative bets.
I think most beginners start like this, as the following quote so aptly suggests:
“The value of hindsight lies in the fact that lessons learned in the past by others can enable subsequent generations to avoid having to learn them anew. And yet, it seems investors must learn those lessons over and over – and often the hard way.”
Thinking about this, it makes sense. If you don’t have any experience and little understanding of a company’s earnings, how on earth could you comprehend something as profound as fundamental analysis? No, it’s much easier to speculate and look for something that seems to be close to the bottom or almost touching the ceiling.
Can I blame my NFLX trade for influencing my earlier approach to the stock market? And did I have bad judgment when I sold this stock for a 70% gain, while I could have had a 650% gain?
The answer is no! The fact is that I had no clue what NFLX was worth, both when I bought the stock and when I sold it!
This leads me to two different investment strategies that I think everyone should know about:
- Value Investing: With value investing, an investor considers the long-term fundamentals of a company, including its financial performance, current cash flows, and projections, to determine an intrinsic value of the stock. If the stock trades for less than intrinsic value, it is considered a good investment opportunity.
- Growth Investing: With growth investing, the focus is on the potential of a company to deliver above-average earnings growth. Even if the stock price seems expensive based on metrics such as price-to-book or price-to-earnings ratios, a stock with great growth prospects is considered a good investment opportunity.
The problem with my NFLX trade was that I failed to recognize that NFLX was a growth stock. When I saw the stock price go higher and higher, setting one record after another, I got scared. I thought that selling for a 70% gain would be considered good timing and that taking the profit before the stock price fell would be a wise move.
Unfortunately, the stock price did not fall but just continued to go higher and higher, and I “missed” out on making a fortune.
How could I have done this differently?
If I knew then what I know now, I would have labeled NFLX as a growth stock. I would have held on to my shares until the company’s growth prospects deteriorated. That’s what you do with growth stocks – you keep them so that they can grow!
Here’s the takeaway message: figure out if you’re a value investor or growth investor. If you choose to combine these strategies, make sure that you know beforehand why you’re investing in a specific stock. Is your reason value or growth-driven?
These days I’m a dividend growth investor and NFLX wouldn’t have made it into my portfolio because the company is not a dividend-payer.
However, even dividend growth investors can learn from this lesson. Dividend-paying stocks are mature stocks with limited growth prospects. One should apply value investing principles when considering such stocks. On the other hand, some younger dividend-paying stocks have above-average growth prospects. One should favor growth investing principles for such stocks. You don’t want to sell a great dividend paying stock just because it is growing fast and offers you lots of unrealized returns!
Do you have any investing lesson that you want to share? Please tell me.