Many individual investors buy and sell based on the latest news, tips, and price action. They may use price targets and stop losses to buy and sell stocks. This approach tends to create a lot of activity, but not necessarily much success. In fact, too much trading is actually one of the leading causes of underperformance by individual investors.
If you want to effectively monitor your stock holdings, stop watching the stock prices and start watching the companies behind them.
Focus on the Business, Not the Price
In his classic 1972 book "100 to 1 in the Stock Market," author Thomas Phelps tells the story of a businessman who sold his companies and invested the proceeds in the stock market. He told Phelps that it was driving him crazy to watch the fluctuating stock prices every day. The stocks he bought went down and the ones he didn’t went up, and the whole experience was causing him sleepless nights.
- Don't get mesmerized by the daily ups and downs of the stock market.
- Instead, focus on the quarterly company reports.
- The reports will tell you if the company is healthy and growing.
- If so, your stock's price should grow, too.
Phelps asked him how he had evaluated the companies he owned before he sold them. The businessman said it was simple. As long as sales were rising and profit margins were good, he knew the business would be fine. He couldn't put a price on any of these businesses every day, so he focused on how the business was performing.
Phelps suggested he manage the stock portfolio the same way. Focus on the quarterly reports and the progress of the business and ignore the daily price fluctuations of the stock. This would allow him to achieve similar successful results while maintaining his peace of mind.
Ignore the Noise
The businessman said he just couldn't do that, and any stock investor will understand why. The information is available, and we feel compelled to check it. It's getting worse, too. That business was operating in a pre-internet world of daily stock quote updates.
The constant churn of buying and selling hurts long-term performance.
Nonetheless, today's investors would be wise to follow Phelps' advice. Companies release their financial results quarterly, and that's when investors should pay attention to the business.
A long-term focus with less activity should lead to higher long-term returns.
It's All in the Numbers
Each quarter, an investor should read the earnings release for each of their stocks and ask some basic questions.
- Are sales growing? If not, why not?
- Are earnings higher than they were in the previous quarter and 12 months ago? Again, if not, why not?
- Has the company issued new shares of stock or increased debt levels? If so, what was the purpose of the offering, and how will the funds be used?
- Are there new products or services being released that could drive sales and earnings growth?
All of these questions will be answered in the earnings release and in greater detail in the subsequent conference call. Investors should read the release and the transcript of the call and evaluate how the business is doing.
It's important to determine if the book value per share is growing as fast as the reported earnings, because everything else in the financial statements ends up being reflected in the shareholders' equity,
If it's not, then you need to know where the money is going. If it's being spent on research and development, that’s potentially positive. If it's disappearing into selling general and administrative expenses, that’s a red flag indicating management is unsuccessfully reinvesting profits in the business.
Over time, book value per share should be growing at least as fast as reported earnings.
Management's Attitude Matters
Investors should judge the company management's attitude towards shareholders. Is the company paying a dividend? Has it been increasing over time? Is it buying back shares of stock to increase the value of the remaining shares? Are they doing so at reasonable valuations, or are they buying overvalued shares to temporarily inflate earnings per share?
If they're buying back shares of stock, is it reducing the number of shares outstanding, or is it offset by stock options and stock grants to management?
Watch the Management
Are any officers and directors making open market purchases or sales of the stock around current prices?
The attitude of management towards shareholders and their ownership and trading activity of the company they manage will be a significant factor in the future performance of the corporation and the stock price.
Focus on the Long-Term
Rather than focusing on arbitrary price targets and daily market action, investors should consider how the business itself is doing.
If the company is growing and profit margins are stable, then you can comfortably hold the stock. If the company is doing well and the stock is down, you might want to consider buying more shares.
When to Sell
If, however, the business is struggling and you can find no valid reason for it to improve anytime soon, it's time to think about selling the stock regardless of the current price action.
Focusing on the business itself rather than the stock price will lead to long-term ownership and lower transaction costs. The real money in stocks is made by patient investors who view their holding as ownership of a business and hold their shares as long as business is good.