5 stock market myths first time investors believe to be true

1. You should always buy stocks when they have fallen significantly in value

Share prices can sometimes fall substantially — share price falls of 50% or more are not uncommon. So when this happens is it always a good time to buy? In short the answer is no.

Remember that while the stock market can be irrational, there can equally be good reasons for a share price fall — sometimes the fundamentals of a business may have changed dramatically to justify the falls. This can even lead to a situation known as a “value trap”, where while the share price has fallen, it is nevertheless still too high and is likely to continue to fall.

To avoid a value trap, compare the fair value of the share with the share price, and only buy when there is a significant discount.

Additionally consider whether the share price fall reflects a change in the fundamental factors of the company, or perhaps is simply an overreaction to temporary global or company specific events.

2. You shouldn't buy stocks which have risen significantly in value

Of course this is the corollary of the first myth but equally misleading.

Again the point is that we are looking for value, not price, and the simple fact that a share price has risen shouldn't exclude it from your investment considerations.

3. Its easier for low share prices to go up rather than high share prices

There is a common myth that its “easier” or more likely for the shares of companies with low prices (ie for example 20c) to rise than those with high share prices (for example $20). While this myth is appealing, it misses the point altogether — we are looking for value, not price, and either company may be equally under or over valued, and therefore more or less likely to rise.

4. You should only invest in the top 20 or 50 stocks

First some terminology needs to be explained — a reference to the top 20 or top 50 refers to the stocks with the highest total market value or market capitalisation. This is simply calculated as the number of shares issued X the share price. For example a company with 100 shares whose share price is $5 will have a market value / capitalisation of $500.

Typically the top 20 stocks will be very well known, large companies — Exxon, General Electric, Apple and so on.

So should we invest only in these companies? We believe not necessarily. While these companies are less likely to become distressed (as measured by our health metrics) through their sheer scale, the considerations of past and future performance, value and income may still not justify an investment.

There are certainly investment opportunities outside the “top” group of stocks which should also be considered, and because smaller companies are less well known, excellent opportunities can sometimes be found.

5. You need expert skills or inside knowledge to be a successful investor

Lets turn to a famous Warren Buffett quote:

'You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.'

In our opinion, the keys to being a successful investor are homework, patience and discipline, not a rare talent or inside knowledge.

Homework — understand what you are investing and why.

Patience — wait for investing opportunities to come your way.

Discipline — don't get caught up with the hype of the stockmarket. Invest in what you want, when you want.