Stock Picks: Advice on How to Pick Stocks
So you want to be a great stock picker, naturally you googled “Stock Picks” and came across my website.
You are lucky you came here, and not to some other website.
The fact that you are googling How to Pick Stocks, What stocks to buy, best stock picks, etc – is proof that you should not be picking stocks.
If you think it’s as easy as Googling it, you are all but guaranteed to lose money.
Let me explain.
First thing’s first – What is the stock market and what are stocks?
You may think the answers are obvious, but they are not. You can’t pick stocks until you understand the rules.
Stocks are little pieces of ownership in a business. If a company has 1,000,000 shares outstanding, and you own 100,000 of them, you own 10% of the company.
The stock market is simply a place where owners of stocks sell their pieces to buyers. Usually, there is a middle-man (your stock broker, for example) that facilities the trade between the stock picker and the stock seller, and makes a fee.
How stock prices are determined
The simplest way to think about stock prices is:
If more people want to buy stocks than sell, the stock prices goes up. If more people want to sell the stock, the price goes down.
Obviously it is more complicated than that in real life, but this is the basic premise. It simply comes down to investor sentiment.
In other words, how investors feel about the stocks they pick.
It’s important to know some of the other factors that influence a stock price, including:
- Relativity to other assets: Stocks as a whole go up when other options are less attractive (ie when interest rates on bonds are low)
- Future Expectations: The stock market, or an individual stock, can go up or down depending on how people expect the future to play out. (Spoiler alert: you can’t predict the future)
- Major events: Unpredictable events such as wars, new technology, new governments and laws can impact how people feel about stocks.
- Recent economic indicators: GDP, unemployment, inflation, interest rates are among a few of the economic indicators that investors watch closely.
But all of these things are either: impossible to predict, based on human feelings (that are fickle; they change quickly) or publicly available statistics.
Meaning, they are basically useless for picking stocks.
The basic mechanism: a stock transaction
The stock market is just a bunch of people buying and selling stocks, facilitated by investment “professionals”.
Therefore, for every stock pick there is a “winner” there is a “loser”.
Consider the following stock market that only has 2 people in it, and 1 share.
Tina buys the stock share from Tim for $5. A year later, Tim wants the share back and Tina is willing to sell it back for $10. Tim accepts this price, and buys the share back for $10.
Who are the winners and losers?
Tina won, profiting $5, at the expense of Tim.
The extra $5 came from Tim’s pocket, and the price was determined by Tim offering a price Tina found acceptable.
The entire stock market went from $5 to $10; based only on the fact that Tim was willing to pay that much for the share.
But let’s not forget the brokers
In our imaginary stock market with 2 people and 1 share, there is a critical person missing: the middle-man.
The stock picking story, more realistically, goes like this:
Tina buys the share from Tim for $5, and pays a $0.10 fee to her broker to execute the trade. A year later, Tim pays his broker $0.20 to buy the share back from Tina for $10.
Instead of the stock market being worth $10.30, which represents the money that went in, it is only worth $10, since the brokers take their fees on every transaction.
This is basically what happens when a fund manager charges a 2% MER, or you pay whatever fixed fee to your brokerage.
There is an important implication here: Every time you pick stocks and win, you win less than the other stock picker lost. Every time you lose, you lose more than the other stock picker won, since each transaction had fees.
So how do you pick stocks to beat the average of all these transactions? aka “beat the market”
The short answer is, you can’t. At least not 99.6% of active investors cannot do it.
You have two huge forces going against you: trying to predict how people will feel in the future (impossible), and trying to overcome the costs of investing.
In the long run, basically nobody has done it. The odds of beating the market are so bad you might as well go to the Casino.
Certainly you wouldn’t bring your whole net worth to the Casino, would you?
The US Stock Market has been a beast
We’ve all heard these types of stories before.
“If you had invested $1,000 in Apple in 1980, you’d be a billionaire today!”
Sure, if only my crystal ball showed me in 1999 that Apple would invent the iPod, iPhone and iPad while I still had a disc-man for my CDs.
So that’s not helpful; it’s impossible to know which companies will be a huge success, and which ones will fail.
But here is a story that would be most helpful
“If you had invested $10,000 in the S&P 500 in 1997, in 2017 you’d have $41,500.”
Substitute almost any 20 year period in US stock market history and in most instances, the gains are substantial.
So why bother trying to learn how to pick stocks so you can beat the market?
It’s already an amazing privilege to be able to capture the entire market’s return for yourself at virtually no cost!
The Average Stock Picker: A very flawed creature
I am proud to admit that the persona of the average investor is one that describes myself in my early days of investing.
I understand this creature well and can easily spot them in the wild. Many of my friends who ask me for stock picks, for example.
Smart people think they can pick stocks; since they were able to use their wits and hard work to build a surplus amount of resources available to invest, why couldn’t they do it with their stock picks, too?
Perhaps they are an above average employee (upper management) or a highly specialized professional (doctor, lawyer) or an entrepreneur.
Overconfidence killed the stock picks.
Being above average in life gives you a dangerous false sense of confidence in investing, especially with your stock picks.
The majority of stock market transactions are performed by professionals, who have risen to the top in one of the most competitive fields in capitalism and are supported by huge teams of analysts, PhDs, the most sophisticated software and the most experienced people.
And even with all those resources, they still cannot pick stocks and beat the market.
Why on earth do you think you will? Especially when your resources involve Googling stuff like “how to pick stocks”, or hearing tips from another average stock picker.
No matter how talented you are, in the stock market, you are the bottom of the food chain.
Ben Graham, the father of value investing, said this in his book “The Intelligent Investor“.
“Yet there is considerable and impressive evidence to the effect that this [obtaining superior results to the DJIA] is very hard to do, even though the qualifications of those trying it are of the highest.”
Just stick to being a great [doctor/lawyer/accountant/whatever], and leave the stock picking to the fools.
Your Biggest Flaw: Your Own Psychology
It doesn’t matter how smart you are, the decisions in investing are pretty simple. Even someone of very average intelligence can understand it.
The reason why most smart people don’t do well is they make mistakes in the moment that aren’t aligned with their simple strategy.
They also believe, because they are smart, that following something so simple can’t be optimal. Why not use all this extra brain power to learn how to pick stocks?
I think this simple cartoon illustrates the biggest mistake “smart people” make.
The problem is you got scared, you panic, especially at the wrong times. You see patterns that don’t exist, such as a continued trend up or down.
You believe things like falling prices makes it more risky, or rising prices makes it safer. (The opposite is true)
Even if on paper, you know this to be wrong, in the moment, you feel that it is true.
No matter how smart you are, it doesn’t mean you are brave enough to not only watch your whole net worth vanish before your eyes, but also buy more as prices fall because of the confidence you have in your stock picks.
Likewise, if everyone around you is “making money in the market”, it’s hard to overcome to social psychology of following them in, for fear of missing out.
In other words, the stock picking proverb “Buy Low, Sell High” might turn out to be one of the most stressful things you can attempt to do.
Your Second Biggest Flaw: You don’t know the difference between investing and speculation
If your basic motive in learning how to pick stocks is to make money, chances are you are speculating.
If you make a stock pick because “it looks like it’s going up”, or, “this company is the future”, you are definitely speculating.
The most important aspects of investing are safety and adequate return.
In other words, your motive needs to be not to lose money.
Not losing money in stocks is simple, and could be easily understood by learning Benjamin Graham’s teachings.
There is nothing wrong with speculative stock picks, and you can indeed make lots of money with it.
But you can also lose, which isn’t a true investment.
The Above-Average Stock Picker doesn’t pick stocks.
If Warren Buffett and Charlie Munger, two of the most successful investors of all time, told you exactly how to get better results than average, would you listen?
How about John Bogle, founder of Vanguard, the largest investment company in the world?
I don’t know about you, but I think these gentlemen know a thing or two more than my friendly neighborhood banker. Or investment sales person. Or, some guy on the internet (me).
So don’t listen to me, listen to them: Buy a stock market index fund and never sell it.
That’s it. If you have extra savings, just buy the index fund, at any price, whenever you have extra money.
Don’t forget the “never sell it” part, that is half the battle.
If you want to know the best way to invest your money, this is it.
I don’t believe it, that’s too simple.
I know it’s hard to believe at first, but simple logic should bring you to this conclusion.
Remember our talk about fees earlier?
Well, index funds basically don’t have fees, at least the good ones (Vanguard, iShares etc)
Immediately, you get an edge over the average investor who does pay fees for similar products, or who tries to pick stocks and pays fees on each trade.
Dollar Cost Averaging
If you can actually pull off the feat of never selling, you at least get the benefit of sometimes buying low.
You can also never sell low, if you never sell at all.
Put simply, you eliminate possibilities of making mistakes. You can never sell low. You can sometimes buy low. And again, you basically won’t pay fees.
Another edge over the average investor.
Bonus: You will less stressed than the average investor
If you don’t care about the price of your index fund (hopefully, you even hope for prices to go down, so you can buy cheaper), all of that daily/hourly stress is completely gone. You don’t have to ever do research, follow news, deal with drops in your net worth, or any of the other negative side effects of being an active (and average) investor.
You just buy index funds when you have money. That’s it. Otherwise, there is nothing to think about.
Talk about sleeping easy.