How investors lose money in the stock market?
Today let's take a look at a few reasons why investors lose money in the stock market. With the S&P 500 up 15.0% year-to-date, & the tech heavy Nasdaq Composite up 31.5% year-to-date, I hope most of you reading this are seeing more greens in your portfolio than reds.
Failing to understand the fair value of the business
They fail to understand what the value of the business is. Often times, investors do not know how to value calculate the intrinsic value or fair value of a stock. There are several methods of arriving at a fair value of a stock. Hence they are cautious as to wether they should buy a stock that has been sold off by the market, and hence appeared unloved. Instead they look for stocks that have risen and then decide that now the stock that they were considering is now loved by the market, hence they buy at a high price.
One example is Nvidia, which was undervalued by around 45% around October last year. Morningstar had a fair value of $200 for the shares of Nvidia. Indeed, after their previous quarter results, Morningstar had revised the fair value to $300, which assumes a fiscal 2024 (year ending January 2024) adjusted price/earnings ratio of 37 times. But the stock price is now currently trading at a premium of 42%.
One of the tools I use is Morningstar, which is a paid subscription service. It is actually quite affordable if you eventually learn how to make back this expense.
Chasing hyped up stocks, failing to recognise traps set by the market maker
The recent trend of artificial intelligence has led to many investors chasing the next big thing. One example is C3.ai stock, which has it’s ticker symbol AI, so what better way to invest in AI that a stock with it’s ticker symbol as AI! The mistake in failing to understand the value again applies here. C3.ai has seen it’s revenue growth slow down in the last few financial years, as of FY2023, it’s revenue growth was 5.5% YoY, FY2022 +38%, FY2021 +16.9%, FY2020 +71%.
However, they fail to understand price action manipulation and the signs of a bull trap. When a stock has risen in a parabolic fashion, it is time to sell and get out if you were in this stock. Again there are strategies to sell, e.g. selling one-third or half of your position as you begin to divest out of the stock, just like when you buy a stock, one would buy in trenches to average down.
Especially considering that the stock went in aparabolic way two times in a short period!
Not understanding the power of economic moat
An economic moat refers to the ability of a business to maintain a competitive advantage over its competitor. In medieval times, castles often had moats surrounding it to protect against invading enemies. Examples of economic moats are network effect, intangible assets, cost advantage, switching costs and economies of scale.
An example of a company with a huge economic moat would be Alphabet. Alphabet is the parent company of Google & YouTube. Google’s search engine is used by many worldwide in countries they operate it, and Google search drives revenue from advertising spend. Most people watch YouTube daily, watching videos of interest to them, and YouTube again generates revenue from selling ads on their platform.
Another example of a brand with a network effect is McDonalds. Have you noticed that McDonalds has a huge brand effect (intangible asset), that its golden arches logo is recognised even by kids, and is often located in a good location in a shopping mall.
Not being able to dollar cost average when a stock price is down
Often times, you hear the word dollar cost average (DCA), which means to buy shares of a stock that you are bullish on at regular intervals. But most of the time, retail investors are afraid to buy more shares when the stock is down on their cost price, due to the fear of “losing” more money. Instead, they wait for their stock to go green on their cost price, and then decide that now is the time to DCA. Doing so only raises the average cost price of their stock. And then the stock starts to dip as market makers take profit and push the price down, and the retail investors panic sell. Buy high sell low is exactly what they do.
There are few ways to take out the emotion and being able to apply DCA effectively. Most brokers these days have a regular savings plan (RSP) to allow investors to automate their purchases. After setting up the purchase, perhaps it’s helpful to delete the app from your phone and not look at it, but only to check it once in a while.
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On the contrary, increased use of AI could help cloud adoption to accelerate to seventy five percent of workloads in the next 3-5 years, from fifteen percent currently. This would drive a big increase in sales by C3 through partners AWS, GCP, and MSFT.
I own C3.ai stock, but it is higher risk investment. Beware of individuals who promote it, incessantly, and ridicule anyone who has doubts. Stay tuned- but don't buy the hype.
Investors can't follow what others say, take advantage of others, and grow their own wisdom, only relying on themselves is the most stable.
Investor must look at the stock intrinsic value before any purchase
I feel that most investors who lose money are people with little financial knowledge.
Yes, there are many people who follow the market (such as AI) and ignore the risk, they must lose.
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