Michael Sivey of Money Magazine, sent the following
email to subscribers about the Psychology of Investing. I thought it
worth passing along.
SIVY ON STOCKS from money.com
October 6, 2000
The psychology of investing
Good stock picking is 90% mental. Here's how to keep your wits about you
and boost your long-term returns.
By Michael Sivy
Without question, the most difficult challenge investors face is
managing
their own emotions. As a rule, people overestimate the size of potential
profits. They also worry about the wrong types of risk, trying to avoid
temporary price dips instead of looking for the best long-term values.
Those tendencies get individual investors into trouble. They extrapolate
current trends and think good times will last forever. Moreover,
investors
develop a herd mentality, and everyone ends up chasing the same hot
stocks.
As a result, investors typically overpay for the most popular stocks,
thinking that rapid earnings growth of 30% a year or more will always
bail
them out. Sometimes it does, but high-fliers with P/Es above 50 rarely
keep
outperforming the market for long. The conspicuous exceptions, such as
Cisco and Oracle, get a lot of attention. But far more crash hard. In
fact,
the highest-priced growth stocks are often outpaced over a decade or
longer
by moderate-growth stocks with 12% to 18% annual earnings increases and
P/Es below 25.
Investors make the same kind of mistake with value stocks, seeking out
deep-discount situations in hopes of a big score. It's a risky strategy
because a lot of cheap stocks are cheap for good reason -- the companies
may be in big trouble. Instead of disasters, value investors should look
for moderately depressed stocks, with below-average P/Es -- maybe 10 to
16
nowadays -- and 8% to 10% annual earnings growth. Even modestly better
results will help those stocks bounce back.
Mistakes in valuation also occur on an industry-by-industry basis. In
the
early 1990s, for instance, the Clinton healthcare initiatives appeared
likely to undermine the pharmaceutical industry. As a result, top drug
stocks such as Merck were selling at P/Es as low as 11 or 12. Today, of
course, big pharma is one of the top-performing sectors.
To profit from major shifts in sentiment, you have to be mentally
prepared
to resist the temptation to join the herd. The simplest and safest
strategy
is to buy quality growth stocks, such as those in the Sivy 100 [http://www.money.com/sivy100
], when they are temporarily depressed.
Develop a list of companies you like in a variety of sectors and track
them. At any particular time, one of two of the stocks on your list will
probably be attractive. The key is to be contrarian about when you buy
--
not what you buy. And you don't have to catch the exact bottom to get a
terrific bargain.
