Investment Basics Archives - Spicer Capital
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5 Ways to Lose Money in Stocks

5 Ways to Lose Money in Stocks

Honestly, most people lose money in stocks. If you don’t want to fall into that statistic, you have to know what to watch out for.

Five of the most common culprits of stock market failure and how to overcome each… coming up!

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Investors make mistakes in the market all the time. That’s one of the reasons there are opportunities for us to generate out-sized returns.

In this post, we cover five of the worst and most common mistakes. (And I bet, even if you’ve see other lists like this, you haven’t heard #5 before…)

If you aren’t prepared for these, you should not have money in the market.

And if you haven’t already seen the deep dive video into the #1 mistake all investors make, you should check it out, because if you don’t avoid that huge mistake, you’ll be helpless against these five.

1. Panicking!

Massive mistake #1 is that most investors panic!

When you really think about it, on the whole, most of the time the market moves predictably. It’s relatively sideways, often with an upward slant. Because that’s only what’s happening most of the time (at least for the last several decades), that’s what we come to expect.

After a decade, we forget that markets go down too. Not in theory—I mean, we admit that it happens, obviously markets come down—but in practice, we don’t actually know or remember how that feels. We’re not prepared. And because it happens relatively rarely, we don’t know how to prepare. But when it does happen—when the market does fall—it can fall fast and hard. And even though that may only happen once every decade or so—each crash unpredictable and different than the last—that’s normal and should be expected.

Maybe you're right to panic...

Now here’s something other financial experts won’t say: I’m not going to tell you blindly that you’re wrong to panic. If you don’t know why you’re invested the way you are—if you don’t understand the reason underlying each of your investments—if you didn’t initially invest preparing specifically for the possibility of a crash… then maybe you should panic. Maybe you should pull your money out of the market.

Invest your time 

In fact, you probably should right now and invest some time in understanding why you’re invested the way that you are. Create an investment plan that is prepared for come what may.

That’s one of my goals with this blog and my YouTube channel: to give you everything you need to get there. So if that’s your goal too, I hope you'll stick around!

Also, if you want to supplement this post, you can check out the free course on this subject at Spicer Capital University. Its four hours of video content will help you overcome this huge mistake.

Calming profiting during inevitable chaos

Ideally, you want to be in a position of investment confidence as everyone else (...who isn't reading this blog or subscribed to my channel...) is panicking. You can observe the chaos with a cool head, because it is during that inevitable chaos we’re going to find some of our best opportunities to outperform long-term! (But that’s an exciting subject for another time…)

​2. Giving In to Euphoria!​

Massive mistake #2 is that most investors succumb to euphoria!

Also known as herd mentality, this one is similar to the first in that it is driven by our emotions. As we see others profiting from a market climb, it's hard to stay on the side-lines—even when we don’t understand or entirely disagree with the investment premise—a lot of people still jump in!

In fact, it’s the most disciplined investors who actually suffer more. Carl Richards, in The Behavior Gap, explains,

The terrible irony in all this is that the people who are trying the hardest to stick to their plans—the ones who hold out the longest before they finally capitulate—are the ones who end up getting hurt the worst because they buy nearest the peak. Once those hard-core holdouts give in, you know the top can’t be far away, because there is no one left to buy.

And in my mini-book, Stop Investing Like They Tell You, I posit,

The opposite is also true. As markets free-fall, it’s the “disciplined” investors who hold out the longest—and suffer the most—prior to their ultimate capitulation.

This euphoria/panic combination has knocked out countless investors.

3. Trading too Frequently

The third most common mistake is trading too frequently.

If you’re a day trader, the mistake becomes trading on emotion instead of your rules, but the negative effect on your long-term returns is the same.

I have a longer time horizon than a day trader, as most investors do. But when you become consumed by short-term fluctuations, you’re going to under-perform.

Not only will you under-perform, but you’ll lose more and more money to commissions.

Emotions strike again

Once again, your emotions work against you here. The solution is to have a plan before you enter each and every position. Based on what you know, play out every possible scenario in your head.

In his interview with Colm O’Shea, in Hedge Fund Market Wizards, Jack Schwager summarizes:

O’Shea views his trading ideas as hypotheses. [He] defines the price point that would invalidate his hypothesis before he makes a trade. And [he] then has no reluctance on liquidating that position.

Almost nobody does this.  We could do an entire series on this practice, how you can do it, and why it’s a good idea. If you’re interested, let me know in the comments.

The bottom line is that investors who trade on emotion (which happens when you don’t prepare for it ahead of time) and worry too much about short-term moves end up making a lot of bad (and expensive) decisions.

4. Getting Emotionally Attached to a Stock

The fourth big mistake is getting emotionally attached to a stock.

I’ve actually heard some industry authorities recommend you invest in companies based on your emotional attachments to them. That is the complete. opposite. of what you should do.

That is… dangerous! Emotions have no place in investing. That’s what makes it difficult, because we are emotional and instinctual creatures by nature. But as you read my posts and watch my videos or do any deeper research into the subject yourself, it becomes obvious that human emotion, in some way, is the primary force impeding most people’s investment success.

Before you make the decision to transfer your money from cash to the stock of a company, or wherever, you need to have analyzed that investment and have a plan. You need to have rules in place. And then you just need the discipline required to stick to those rules.

But if you don’t—if you decide to skip this part—if you just take a position because you like it or for some other emotion-driven reason, you probably shouldn’t be trading on your own.

And that’s okay… don’t feel like you have to.

Now, that process I just outlined of emotionally evaluating each trade before it is made is deep and more advanced. But it’s pretty imperative to lasting investment success, so you can bet we’ll dissect every aspect of that further to make it really easy for you to follow and thrive. So stay tuned!

5. Speculating Instead of Investing​

Investment mistake #5 is that most people are actually speculating when they think they’re investing.

  • If you don’t fully understand why you’re invested in a certain way, you might be a speculator.
  • If you don’t know when you plan to get out—if you’re just “playing it by ear,” you might be a speculator.
  • If you heard a good idea, didn’t have time to research it, but took a position just so you don’t miss anything… you might be a speculator.
  • If you just liked the prospects of a company’s product, so you bought some shares, you might be a speculator.

If you haven’t completed your own analysis of the company’s financials or you have no basis for any assessment of a fair value​, you are speculating!

Far too many individual stockholders in the market have never gone through any sort of formal analytical process to come to an educated decision about the investment they’re considering. If that’s the case, at best, you’re speculating; at worst, you’re gambling. Both can be disastrous long-term.

I put together a short video series explaining the differences between investing, trading, speculating, and gambling. Especially if you hold individual stocks, or would like to, you should check that out.

And if you’d like to learn more about that analytical process, I’m building a playlist for you on fundamental analysis. Stay tuned, cause we’ll definitely be covering that more over time.

So Many Potential Mistakes

Now, I want to hear from you. We just covered five of countless mistakes new investors make. What are some others you’ve seen or experienced yourself?

I hope this has been helpful for you as you start your journey to building your rapidly-growing, highly-diversified net worth. If so, be sure and stick around, because there is so much more to learn!

What Is PE Ratio?

What Is PE Ratio?

One of the fundamental ways to value and compare stocks is with the PE, or Price-to-Earnings, Ratio. If you plan to do anything in the investing world—even if that’s just spectating or watching CNBC—you’re gonna feel lost if you don’t understand this ratio.

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Because a company’s share price does not in any way reflect its value, it’s not helpful at all in our effort to value and compare companies. Apple, despite its $150 share price, is still worth $150B more than Amazon, with its $1,500 share price.

Price-to-Earnings Ratio

The Price-to-Earnings Ratio provides us a simple way to assess the value we’re actually getting when we purchase a share. It measures how much you’re paying for every dollar of a earnings.

You can use the PE ratio to gauge how similar companies in similar industry sectors compare to each other.

The Variables

The PE ratio is made up of two variables: a company stock’s Price Per Share, or PPS, and a company’s Earnings Per Share, or EPS.

Price Per Share is easy to see. It’s simply the share price at which a company’s stock is currently trading.

Earnings Per Share

EPS, on the other hand, requires a little calculation. It’s the company’s profit divided by the number of shares outstanding: the amount of profit that could be attributed to each of those individual shares you’re considering purchasing.

It's the kind of calculation you would do with any investment: I’m going to buy this house for $100,000, which is renting for $5,000 per year—that would be your Earnings Per House.

There's obviously a lot more that goes into your decision, but when you’re considering an investment, you want to know how much its producing. Earnings Per Share gives us a quick and easy (albeit incomplete) glimpse at this.

Thus, when you’re comparing the price of a share to the earnings per share—in other words, when you evaluate the PE Ratio—you learn how much investors are willing to pay for every dollar of earnings, or how much you would have to pay for each dollar of earnings.

Examples

At the time of this recording, Google (or Alphabet’s) shares are trading around $1,000 per share. Its Net Income over the last 12 months was just under $17B and there are about 700MM total shares outstanding. That means they earned around $24 per share ($17B/700MM shares). With that information, investors have been willing to pay the current $1,000 price per share; they’re willing to pay around $42 (Price/EPS or $1,000/$24) for every dollar of earnings. You could say Google has a PE Ratio of 42.

You can compare that to the fact that investors are only willing to pay around $16 for every dollar of earnings from Apple: Apple’s PE Ratio is 16.

Netflix’s is a little over 200. Amazon is over 250.

You might also want to use this number to compare a company to its industry or sector. The technology sector, for example, right now has an average PE Ratio of just under 43.

Or you could look at the market as a whole. For example, you could use the Standard & Poor’s 500 as a proxy for large United States companies. It’s PE Ratio right now is around 25.

How to use PE ratios in research

From these numbers, it would appear investors are expecting much more future bottomline growth from Amazon than Apple. If you have reason to disagree—if you  believe Apple will grow just as much or more than its competitors—perhaps you have the start of an investment thesis that Apple is undervalued, and thus would make a good investment for your dollars.

Or, on the other side, maybe you think investors are overestimating Amazon’s future,  and you have a case for its stock being overvalued.

Neither one of those reflects my personal opinion. They just serve as an example of how PE can offer a down-and-dirty, side-by-side industry comparison—and how it could help steer the direction of your research.

Where PE falls short

So, depending on how you compare it, a company could appear over-, under-, or appropriately valued based exclusively on its Price-to-Earnings Ratio. But obviously, there is much more to a company than its earnings over the last 12 months.

For example, as I just mentioned, this calculation in no way accounts for expected future growth, which is likely the reason Amazon consistently maintains a high ratio. On top of that, it also doesn’t accurately account for a company’s current financial position (considering important factors like debt and cash reserves). Many investors prefer to use a metric known as Enterprise Value to account for that as well. Additionally, consider the fact that net income does not accurately account for a company’s current operating performance, like the metrics EBIT or EBITDA might.

If you missed either of the videos I did explaining those subjects, be sure to check them out.

Take-away

Despite its shortcomings, you’ll still hear PE Ratios referenced all the time in the investing world. Its quick-and-easy calculation offers a convenient metric for initial comparison and cause for further research and analysis. But you should stop there. Definitely do not use a company’s PE Ratio as the primary driver for your investment idea. Try to figure out what else is going on with the company. Is there a reason for any discrepancies you may have discovered?

I hope you find this information helpful on your path to building your rapidly-growing, highly-diversified net worth. I really do hope so, because that’s my goal. If so, stay tuned, because I have a whole lot more in the works for you!

What Is EBIT & EBITDA?

What is EBIT & EBITDA?

What is EBIT? What is EBITDA? Which is better to use and when? Why can’t I just use Net Income? All the answers... coming up!

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Net Income Is Not Enough

When you’re trying to figure out how profitable a company is, you might be tempted to just look at the bottom of its income statement, its Net Income. Logical—but that number is not super helpful when attempting to value a company. The reason for that is because there are several “expenses” that come out before the bottom line that aren’t truly representative of the company’s current performance.

EBIT

A better place, where many successful investors look, is a little higher up on the statement. It’s called EBIT, or Earnings Before Interest and Taxes. This is Net Income exclusive of the company’s interest expense and taxes.

The reason that’s valuable is because neither of these exclusions represent the company’s current performance. The interest they pay has to do with past financing terms. And the taxes a company pays vary based on geography (...and the mad-tax skills of their accountants). So removing both of those offers a clearer picture of current income.

EBITDA

Wall Street likes to stretch this idea even further with EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization.

An argument can be made for not including a company’s depreciation expenses because they represent the historical investment decisions a company has made, not current performance. Especially for capital-intensive industries—like telecom or oil and gas—this metric could prove more useful.

Buffett's take on EBITDA

Even though EBITDA is an industry norm and commonly used, a counterpoint from Warren Buffett should be considered. He plainly observes, "In respect to EBITDA: depreciation is an expense; it's the worst kind of expense." [emphasis added]

So, if you choose to use EBITDA for your analysis (as many successful investors do), to respect Buffett’s point, be sure to at least specifically evaluate and compare the depreciation expenses of the company you’re researching, because it does still have a major impact.

EBIT > Net Income

So now you know: Net Income, we love you, but you’re not giving us the full picture. It’s not until you add back the taxes and interest (and maybe the depreciation) that you can really use these numbers (and ratios derived from these numbers) to compare different companies.

We’ll definitely be exploring some of those ratios and additional metrics you can use as you build your rapidly-growing, highly-diversified net worth, so stay tuned!

What Is Enterprise Value?

What is Enterprise Value?

What is enterprise value? Why is it used by so many successful investors? And what are all the parts of the equation that make up this important metric? All the answers… coming up!

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Market Capitalization

The most straightforward way to value a company is by multiplying its share price by the total number of shares outstanding. This gives you (what is called) a company’s Market Capitalization, or Market Cap for short. Essentially, this tells you how much it would cost to buy every share of a company—to own 100% of that company.

This simple metric is what’s used when stocks are divided up by their size. For example, the Standard & Poor’s 500 (S&P 500) is supposed to represent 500 of the largest United States companies as measured by Market Cap.

Why EV > Market Cap

But for a successful investor—trying to fully understand the value of a company, not just what all the shares are worth, but the actual complete picture of a company’s value as an investment—this metric is not enough. (And I hope that statement makes more sense to you in just a second.) Because of this, more often than not those successful investors use Enterprise Value, or EV.

Enterprise Value more accurately represents the net impact—the bottom-line effect as an investment—on the portfolio of a potential acquirer who might take full ownership of a company. 

So… if you’re buying shares in a company (you know, actually becoming part owner in that company), knowing what you would be out-of-pocket if you could just take over and purchase the whole entire thing (not a bad perspective—putting yourself in the shoes of a potential acquirer), that’s valuable information, right? It’s at least a more realistic representation than Market Cap of the value the market currently assigns to the company in question.

The Variables

Five variables go into this calculation, and when you think about each one, it’s obvious why EV is more comprehensive and useful than the traditional Market Cap.

Market cap

You start where we’ve already started, with the company’s Market Cap—what you would have to pay to buy 100% of the shares outstanding, becoming 100% owner the company.

You just bought the entire company, so that will increase your assets (right?)… but that’s not the end of it. That’s not the only effect this acquisition will have on your financial situation.

Plus total debt

If you’re now 100% owner of the company, you also now own 100% of its debts—both long- and short-term. So you need to factor that in. You can do that by adding it all to the Market Cap. Pretend as though, upon purchase, you’re also going to pay off every single creditor. (You don’t have to do that, but you will owe them all money at some point… so it needs to be factored in.)

Minus total cash

On the other hand, what if the company comes with some cash or cash equivalents? Well, that helps. That’ll work in your favor, so you can subtract that amount from the total amount you’re essentially paying for this company. Sometimes, this can be significant. Apple, for example, as of this recording, has well over $250B in cash reserves! Obviously, when you’re thinking about your Apple takeover bid (or just your own valuation of the company), this should factor in.

That’s most of your Enterprise Value calculation: Market Cap + Total Debt - Cash.

Plus other ownership interests

Now, I said there were five factors. There are. The other two are usually pretty small, if they even exist at all for your company in question.

At times, there are Minority Interests and/or Preferred Shareholders out there. These are other people or entities with claims to the company. Of course, then, they should be added in as well. They, too, are not considered in your basic Market Cap calculation, but obviously represent some value.

A Clearer Picture of the Actual Value

So there you have it: a simple way to gain a clearer picture of the actual value of a company. Market Cap + Minority Interest + Preferred Shares + Total Debt - Cash = Enterprise Value. And Enterprise Value comes up a lot in the ratios used to compare and assess the fair value of different companies.

We’ll be exploring some of those ratios, as well as other important metrics as we continue to build out your rapidly-growing, highly-diversified net worth, so stay tuned!

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