In this video I discuss the biggest investing mistake.
VIDEO SUMMARY
This video is on the biggest investing mistake. I wanted to make a video about this because this is a mistake that I hear people make all the time. What is crazy is that the people making this mistake should know better. I talk with a lot of people about finance, and some people I hear making this mistake are accountants, business students, business owners, executives. So it is a pretty common mistake and it really has to do with an understanding of the nature of investing.
Before we jump into the discussion of the mistake, what I would like to do is start with a more tangible example. Sometimes the financial concepts are difficult to wrap your head around. So I want to start with an example that most people have experience with. That is purchasing a used car. Let us say you go out and purchase a used car. And you are very happy with your purchase. You are so happy that you go take your car over to your friend’s house and you say, “Man, look at this used car I purchased. I got such a great price. I got such a great deal. This car was a really great purchase.” That is the example. The question I want to pose is what do you mean when you say “you got a great deal?” What does that really mean?
What you are really saying is there is a mispricing in the market that you took advantage of. What really happened is you bought a particular car with a certain set of characteristics. There are other cars out in the used car market with similar characteristics. You could go down the street to another used car lot and buy a similar car at a different price. But by you acknowledging that you got a great deal on this car, what you are really saying is that compared to similar cars in the market, on this purchase you got a lower price than what other cars are selling at. In that framework, you took advantage of a mispricing in the market. You bought a car that was undervalued and to take it a step further, what you are really saying is that you made an instantaneous profit. If you bought a car that was undervalued, that suggests that you could go out into the market the very next day, put the car up for sale, and sell it to somebody else for a price that similar cars are selling at in the market and make a profit over what you bought it for. So that simple statement, “I got a great deal” actually has a lot going on in it. I suggest that it means you are taking advantage of the mispricing in the market.
So let us bring this discussion back to investing and the mistake that I am talking about. This mistake is how people are talking about their investments and thinking through their investment decisions. I will have conversations with people and they will go something like this… They will come up to me and they will say “I am so excited about this stock purchase I just made. I bought the stock I found for this great company. The company has strong financial standing. It is growing every year. Its revenues are increasing every year. It is making a ton of profits. This company is going to make so much money, and now that I own stock in that company that money is going to flow through to me through that stock.” That is the mistake. The mistake here is that is an incomplete argument when you are talking about investing.
To define this further, I am going to put up a definition of what I am talking about. The mistake is this: It is the failure to separate two distinct concepts. The two concepts are: the quality of the company, and the attractiveness of the stock price. These are two distinct concepts and the idea is that the statement that person made about how this is such a great company is only talking about the first concept of the quality of a company. That is an important concept to understand, but there is also a second concept going on implied in every purchase. That concept is the attractiveness of the price. Is the stock overvalued, undervalued, or is it appropriately valued? This is important because you can buy the stock of the greatest company in the world. This could be an amazing company, and it does not really matter if you buy the stock at a bad price. If you buy the stock when it is overpriced, that stock is eventually going to correct and you are going to lose money. So it is helpful to understand this as two separate concepts.
To bring this back to the example we discussed earlier about the used car. What you are talking about when you say “I got a great deal” is you are really talking about this mispricing in the market. The same goes for purchasing stock. What you really want to be able to do, is purchase the stock that is undervalued for a great company because then when the stock corrects, you are going to make a return on your investment. That is really what you should be saying when you talk about your investments. You should be saying “I just bought the stock of a great company, and I also identified a mispricing in the market that when the market corrects, I am going to make a return on my investment.” I want to be clear here. I am not giving any investment advice in this video. I am not even suggesting you should invest at all. What I am trying to do here is expand your understanding of the financial decision-making process and this is going to go into some of the other financial models that we are going to talk about in some of these videos. If you can get better at the investment decision-making process and separating out these two concepts when you make these decisions, you are going to make better investment decisions. You are going to make better financial decisions. You are going to make better business decisions and that is really what this is all about. Being able to look at a market and not only identify what the good companies are but being able to identify what is the stock price telling us about these companies. Are the stock prices mispriced and can I take advantage of that mispricing?
This is a complex concept and we are going to talk more about this in the next video where we talk about market pricing. To recap, we started by talking through an example of a used car purchase and how that relates to taking advantage of mispricing in the market. Then I gave an example of the biggest investing mistake and defined it. And finally I explain why it is important to understand the very nature of investing.
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Neither Zach De Gregorio or Wolves and Finance Inc. shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.