4 Real-World Investing Lessons You Need to Know


After 13+ years of looking at the market on a daily basis, and flushing a whole bunch of cash down the drain on idiotic trades, I've grasped a few realities about how money moves in the real world — far away from the textbooks and theory pushed at your average business school.

Here are 4 of them

1. What You Know, Everyone Else Probably Knows, Too.

Investors have a tendency to overestimate the uniqueness of their ideas, even though we're all drinking from the same information cup.

Furthermore, the presence of social media outlets like Twitter (TWTR and Facebook (FB) have drastically accelerated the speed at which investable information is distributed.

That means that with few exceptions, everything gets priced into the market pronto.

So if you're thinking of buying bank stocks because The Fed's about to raise rates, or shorting  Apple (AAPL) because of slowing revenue growth, slow down and take a deep breath.

It's important to understand the past and present.

But to be a successful investor, you'll have to predict the future — a far bigger challenge than skimming through 10-Ks and listening to earnings calls. In other words, focus on examining not where the fundamentals and newsflow are, but where they may be going.

Remember, when a guy on TV tells you a stock is good because it's trading at X times earnings and has Y in cash on its balance sheet, he's simply repeating the bare minimum of what the market knows.

As men wiser than me have said, “What the market knows is not worth knowing.”

2. Timing Is Everything.

When looking at the market,it's important to understand not only “the what,” but “the why.”

But the more I think about it, the more I'd argue that “the when” trumps both those considerations.

Let me tell you a story.

I once interviewed at a hedge fund that was making a major bet on its prediction that the then-growing housing bubble would implode.

Smart money, right?

However, that interview took place in early 2003, right before the Housing Index (^HGX) doubled.

Likewise, a lot of folks were short FitBit (FIT) year as it crashed and burned from that $51.90 high hit last August.

But a lot of bears got smashed on the 73% rally that precded the drop.

So when you have an investment thesis in your mind, ask yourself, “What makes now the right time to bet on this?”

Furthermore, if the S&P 500 is skyrocketing, it is entirely likely that junky companies rally big-time.

Likewise, if the market's in meltdown mode, even the best of the best can get smashed.

Apple (AAPL) closed out 2007 at $198.08. But in 2008, even in the face of enormous earnings beats and the halo of the iPhone's unprecedented success, Apple finished the year at $85.35 — a drop of 57%!

You may be smart, but remember: Sometimes Mr. Market just does not care about what you think.

3. You Are Probably Suffering From Confirmation Bias.

The Oxford Dictionaries defines confirmation bias as “the tendency to interpret new evidence as confirmation of one's existing beliefs or theories.”

Translated into financial terms, it means that if you're bullish on gold (GLD), you interpret everything you see as bullish for gold.

I know the power of confirmation bias from a horrible experience with a former tech highflier called Rackable Systems, which changed its name to SGI (SGI) after it acquired Silicon Graphics in 2009.

In 2006, Rackable Systems was a momentum King — kind of like newer names like Acacia (ACIA). It was pulling in boatloads of money selling energy-efficient servers to major data-center operators like Microsoft (MSFT), Amazon, and Yahoo (YHOO).

And then — let me point out that I had complete knowledge of this — competitors like Hewlett-Packard (HPQ) decided they wanted some of those data-center dollars.

Maybe I should have imagined what would happen if Rackable lost Microsoft (34% of revenues) or Yahoo (26% of revenues) as a customer, or at the very least, the margin pressures that could be introduced in a more competitive server environment.

However, I viewed the new competition as nothing less but confirmation that Rackable was on the right track.

And then Rackable crashed from $56 to under $10 as earnings collapsed.

It is impossible to stay perfectly objective when performing research.
But you can stay one step ahead of your own bias by regularly asking the question, “Am I just telling myself what I want to hear?”

4. In Isolation, Valuation Ratios Are Useless.

Investors often take a simplistic view of valuation ratios, automatically assuming that if something is “cheap,” it's good, and if it's “expensive,” it's bad.

But you'll often see cheap stocks get cheaper and expensive stocks get more expensive.

How many times has someone told you that Salesforce.com (CRM) is overpriced?

Next, look at the stocks' chart since it went public:


A P/E ratio, like every other valuation ratio, is 100% meaningless in isolation.

It is far more important to examine how the “E” part of the equation is changing. (Or sales for EV/S ratios or EBITDA for EV/EBITDA ratios, etc.)

A company trading at five times earnings can look awfully expensive following a bad quarter that destroys future earnings expectations. That's how a stock like GoPro (GPRO) can go from $98 to $50 to $9 in the blink of an eye.

It also works the other way around — a high-priced momentum stock can suddenly look cheap if earnings come in ahead of expectations and forward estimates rise.