Many people want to purchase individual company stocks. There’s nothing wrong with that.
Investors hear of a company that is surging in the market or that is launching innovative products and want to own the stock to reap the financial gains. Or maybe they read an article or an investing newsletter that touted the prospects of the company and want to buy in before everyone else discovers the hidden gem.
Technology has made it remarkably easy and, in most cases, inexpensive – if not free – to buy shares of companies traded on public exchanges.
It’s a wonderful thing. But be careful.
Just because you can buy stocks of individual companies, doesn’t mean you should. In viewing other peoples’ portfolios, I am continually reminded of how hard it is to successfully invest in individual companies and outperform a simple index, such as the S&P 500, which is a collection of 500 of the largest U.S. companies.
Investing isn’t a game of luck. The best investors treat it as a serious endeavor that consumes untold hours. These investors attempt to know everything they can about the companies in which they invest. They know its products and services. They investigate its competitors. They talk to its suppliers. They evaluate its prospects for future growth. They interview the company’s key managers.
And then, once they form an understanding of those things, they analyze the company’s financials. How is the balance sheet situated? What is the net income margin and historical growth in earnings? Finally, they form an appraisal of what the whole company is worth to make sure they aren’t overpaying by buying shares at the current trading price.
To be successful as an investor, you need to do the same.
Okay, to be fair, you don’t have to do any of those things. You could just buy the stock. None of what’s mentioned in the prior paragraphs is required. But if you don’t do those things, you dramatically reduce your chances of achieving a successful outcome, defined as outperforming the S&P 500.
Let me tell you what I typically see for portfolios of individual companies.
There are a few rocket ship stocks that blast far higher than the original purchase price, a few stocks that have fallen in value by 40% or more from the purchase price, and a lot of stock positions that fall somewhere in between. But when you examine the performance of the entire portfolio, especially over periods of 10 years or more, the investor would have done better by investing in a simple S&P 500 mutual fund.
Despite being easy to get into, investing is a hard pursuit to do well over time if you only invest in individual companies.
That doesn’t mean I necessarily discourage it. But you need to know the deck is stacked against you. You need to understand that some investors are paying millions of dollars for research on the very companies you are looking to purchase. These investors know more about the company than many employees who work there. In fact, they may even be talking to employees – and industry insiders and regulators – to get a better sense of how the company is performing.
If you’re not doing that, they have an edge on you.
Being successful as an investor takes substantial time and effort – more than most people are willing to give.
If that’s the case, there’s no shame in investing in mutual funds or other exchange-traded funds that bundle a bunch of stocks into one neat package that you can buy. In fact, in my opinion, that’s what most investors should do.
So before you invest in individual companies, build your knowledge of the company, its industry, and its financial affairs. That’s the best way to boost your odds of netting a favorable outcome.
Anything else is just a more respectable form of gambling.