Millions of Investors are Making This Mistake -- Here's How You Can Avoid It
True confessions: I've been known to engage in chart chasing.
"Chart chasing" is a nickname coined by StreetAuthority co-founder Paul Tracy to describe the practice of running to the nearest digital device to pull up a price chart whenever someone mentions a stock.
And why not? On the surface, a quick glance at a price chart seems to tell you a lot. In a split second, you can see where a stock is currently priced in relation to its history. And, depending on the program, you can compare that stock's performance with any other company and the market as a whole, to mention just one possibility.
Chances are a lot of you are chart chasers, too. After all, for an investor, what's more rational than the urge to punch a ticker symbol into a waiting chart program after encountering a stock for the first time?
But it's what you do -- or don't do -- after you check out the chart that counts. It can mean the difference between making money in the stock market and losing money.
For instance, if your "buy" or "sell" decision is based largely on whether the trend line is sloping upward (or downward, as the case may be), then you could be asking for trouble. That's because "historical price charts in and of themselves are meaningless," Paul asserts. "Future performance AFTER you buy the security is what really matters."
For one of Paul's classic examples of chart chasing gone awry, take a look at this stock...
What could be better than a 344% gain in less than a year and a half, with no let-up in sight?
How about an endorsement from CNBC's Jim Cramer...
"Yes, (the company is) expensive here, selling at 38 times next year's numbers," Cramer told his Mad Money viewers in October 2011. "And there are concerns. But no, I'm not worried anymore. Not after this quarter."
...or a vote of confidence from Deutsche Bank (NYSE: DB), which in February 2012 boosted its price target on this company and reiterated its "Buy" rating...
Following a meeting with management, "We picked up some incremental positives that reinforce the unique nature of (this company's) growth story and suggest comps and the earnings multiple could stay elevated for some time," the bank wrote in a note.
That's Wall Street speak for, "We think this stock is a 'buy'."
And this stock WAS a buy -- until it wasn't...
Two months after the Deutsche Bank plug, reality began to set in for Chipotle Mexican Grill (NYSE: CMG) and its theretofore enthusiastic shareholders.
Here's what Chipotle 's chart looks like since the stock hit a 52-week high of $442.40 in April 2012...
After fluctuating in a sideways-to-downward-trending pattern for several months, Chipotle tanked nearly 22% in a single session in July after the company released a disappointing quarterly report.
The plunge wiped out all of the stock's 2012 gains. The culprit -- substantially slower traffic growth at the chain, which the company blamed on a sluggish U.S. economy and slowing consumer spending.
Like yesterday's newspaper, the chart merely "reported" what happened to Chipotle's share price on that summer day -- it didn't anticipate the move, which likely left many Chipotle chart chasers wondering what hit them.
With a chart, "the only data you have is past market behavior," says Paul. "At this point you know little to nothing about what actually makes this company work (or not). Price charts don't tell you anything about a company's underlying fundamentals."
That's especially important to keep in mind as the market edges closer to its all-time highs, taking many companies along for the ride -- some deservedly so, many others not so much.
So what's the antidote to the seductiveness of upwardly-sloping charts?
In the following interview, Paul gives a preview to a short webinar he put together exclusively for subscribers to StreetAuthority publications. In it, Paul discusses what he has found to be the key to consistently making money in the stock market, no matter what the environment. To view the webinar, follow this link.
Bob: Why do so many "chart chasers" lose money in the stock market?
Paul: They lose money because they put too much emphasis on the wrong information.
Let me explain.
The average small investor looks at historical price charts... reads a few analyst reports and a few website articles... perhaps listens to what the talking heads have to say on CNBC... and then he or she makes a decision to buy a stock.
This approach is dangerous.
I know for a fact that it's dangerous because, to be perfectly honest, this is how I used to invest. And back when I invested this way, I lost money in the stock market.
But about a decade ago I started taking a different approach, and in recent years that approach has helped me consistently make money in the markets.
That's why I put together this webinar. Because I want to help our readers become better investors.
And if you want to become a better investor, then the first step is to stop focusing on irrelevant information.
Price charts don't tell you anything about a company's underlying financial performance. They also don't tell you whether or not a company is consistently returning money to its rightful owners -- its shareholders.
Sadly, the average small investor puts too much emphasis on historical price charts. In doing so, they look for companies that have delivered consistent share price gains in the past, and they incorrectly assume that those gains will continue in the future. But if 20 years of investing has taught me anything, it's this...
Past share price behavior is not the best predictor of future performance.
So when an investor looks at a stock's price chart and uses that data to make a buy or sell decision, I believe he or she is making a big mistake. And sadly, this is exactly what millions of small investors across the globe do every single day.
Bob: What should investors be looking at instead? What have you found to be the key to making money in stocks?
Paul: I believe the following factors are the most important things to look for...
1. Companies that dominate their markets
2. Companies that have clear competitive advantages that keep rivals at bay
3. Companies that generate enormous cash flow
And most important...
4. Companies that return an increasing amount of money to shareholders each year through dividends and share buybacks
This last point is critical.
I don't view stocks as lottery tickets, and I don't look to buy them one day and sell them at a higher price a few days or a few months later.
Stocks represent ownership in a business, and my goal is to invest in some of the world's greatest businesses and to hold those stocks for the long haul. And as I explain in my webinar, if you're going to buy a stock and hold it for the long run, then as a rightful owner of the business, you should receive your fair share of the company's profits.
With this in mind, I don't personally invest a cent in any business unless it either pays dividends or buys back its own stock... or ideally does both.
This approach is supported by countless research and academic studies.
For example, dividend-paying stocks have a long history of outperforming the market through good times and bad. The chart below tells the whole story.
From 1972 through 2011, members of the S&P 500 that pay dividends returned 8.6% annually. That's enough to turn a $1,000 investment into $27,036. Meanwhile, non-dividend payers returned just 1.4% per year, turning that same $1,000 investment into just $1,710.
And as you can see, companies that grow their dividends have done even better. That's why I look for companies that boost their payments to shareholders year-in and year-out.
Bob: Based on those criteria, what's a current favorite of yours?
Paul: Probably the single best example of this right now is Intel (Nasdaq: INTC).
If you look at a historical price chart for Intel, it looks downright ugly. The stock has moved up and down a bit, but it has literally gone nowhere for ten years.
After looking at the price chart, millions of small investors have come to the conclusion that Intel is "dead money."
But I think they're wrong.
You see, although Intel's share price has been stagnant in recent years, the company has been creating huge value for its shareholders through dividends and buybacks...
Cumulative Shares Repurchased
This value will eventually be reflected in the share price. And I'm more than happy to sit back and collect Intel's solid 4.4% (and growing) dividend while I wait for that to happen.
Meanwhile, Intel dominates its industry (it controls about 80% of the microprocessor market), it has clear competitive advantages that keep its rivals at bay (the firm builds cutting-edge chips thanks to its huge research & development budget), and it generates enormous cash flow (about $20 billion a year).
As the company moves aggressively to capture its share of the booming market for smartphones and tablets, I'm convinced Intel will continue to reward its shareholders with even greater dividends and share buybacks in the years to come. And that should translate into big gains for investors.
Bob: Intel? Really?
Paul: Yes... Intel's stock has gone nowhere for the last ten years. And yes... I know that for many investors, that makes it emotionally challenging to invest in the company now. But if you ignore the price chart and you focus on the underlying fundamentals, Intel is an outstanding "buy" right now.
I'm sure I'll get some hate mail on this, and that's fine. But remember -- I'm not suggesting you buy Intel a decade ago. I'm suggesting you buy it today. And if you buy the shares now, then the last 10 years of share price movements are irrelevant. They won't impact your total FUTURE returns by a single cent.
Action to Take --> Instead, I think you should focus your attention on the four lessons I outlined earlier. Do so, and I'm convinced that you'll not only become a better investor, but you'll also make much more money in the markets.
StreetAuthority LLC owns shares of INTC in one or more of its “real money” portfolios.