The most successful investment I ever made was in an online gambling business. The shares flew from 7p to over four quid!
During the stock’s ascendency, I offered the tip to several friends and acquaintances. A few followed me in and did very well. But others talked themselves out of it: “I’m not sure. What about the ethics involved in gambling? A business involved in morally questionable activity can’t be a good long-term bet.” And, “Isn’t this area open to intense online competition?”, or “Look at the price! It’s already tripled. I’ve clearly missed the boat!”
My friends instinctively decided not to invest. Their gut told them not to do it, and then they invented sensible-sounding reasons for their decision.
Gut reactions are all well and good when it comes to some things. But when it comes to investing, gut reactions can be totally counter-productive. The sub-conscious makes excuses as to why the gut instinct is right – it presents your biases as hard fact.
And the point is, following your gut is usually a terrible way to invest. It can scare you away from big gains. But all you have to do is look at the cold-hard facts to quash these biases.
Today I want to show you a couple of examples of how this instinct has worked against many investors recently. And we’ll see how you can very easily overcome these emotional barriers to successful stock picking.
How to spot your biases
As an investor, you need to recognise that little emotional tug that ‘likes’ or ‘hates’ different assets. That’s what a bias feels like. You might never be rid of these biases, but you can train yourself to spot them – and then ignore them.
In fact, all you really need to do is invest a little bit of time in analysing a few key numbers from the accounts and you’ll quickly see what’s really going on. Look at the turnover – is it growing? Look at margins – are they growing, or if not, are they at least stable? Look at cash flow – is the business actually bringing in the money it claims to be making in the profit and loss account?
It doesn’t matter if there’s intense competition – not if the company is still growing and increasing margins. And as for buying a stock in the ascendancy – who cares! What we’re interested in is whether the stock is trading at the right price relative to current earnings. Yesterday’s price action is yesterday’s story.
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Two unloved stocks
Spreadbet operator IG Index is a company that investors love to hate. Operating in what many consider to be a ‘dodgy’ sector, gut reactions tell them to steer well clear.
But I’m a long-term advocate of IG Index. And figures out yesterday didn’t disappoint. UK revenue was up 16% on the comparable quarter last year, with revenues per client up 28%. I predicted that volatile markets would drive revenue – and they did.
In my last update on IG, I also noted that that marketing spend in Europe had been running high, thereby depressing margins. So yesterday’s news that European revenue was up a staggering 30% quarter-on-quarter is great news.
Yesterday’s release was an interim management statement (IMS), so no figures on profits (hence no news on margins). But from what I can see, these increased revenue figures portend well. The shares have been performing very well. But hold on for further upside.
I’ve backed Supergroup (SGP) from the get go. I talked about SGP from day one when it floated on the stock market. And from that day, the critics have said that this brand would be a flash in the pan. In fact, even three years ago, many were saying that the brand was already on the wane.
And my response has always been the same. I don’t know much about fashion. Maybe you do, and maybe you’ll be proved right one day. But I do know about accounts, and to judge by the accounts, the business is going from strength to strength.
The naysayers at one point made SGP the most heavily shorted share in London. That’s when I suggested this was a fantastic opportunity for investors to top up. Anyone that picked up stock around £3 last year will be sitting pretty now that the stock is back up around the £12 level.
Now, I’m not saying that I get every call right. I most certainly do not. I mean, just look at the Co-op bonds I mentioned, and that was supposed to be an ethical business! Hmm… maybe I should stick to vice stocks.
But what I am saying is that gut reactions can be a very shoddy barometer of investment opportunity. And there’s no need to trust gut instinct. Simply look at the cold, hard accounting data in a dispassionate way, and you’re much more likely to pick the winners and steer clear of the losers.
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
Information in The Right Side is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. The Right Side is an unregulated product published by Fleet Street Publications Ltd. Fleet Street Publications Ltd is authorised and regulated by the Financial Conduct Authority. FCA No 115234. http://www.fsa.gov.uk/register/home.do
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