Good Company is a Good Investment Fallacy
A common mistake in investing is confusing a good company with a good stock.
Good Stock
Section titled “Good Stock”A good stock is a stock that when bought will earn you a return on your money over your investing time frame.
Good Company
Section titled “Good Company”What people describe as a good company is often one that they believe will continue to grow over time. The problem is that this growth is already priced into the shares of the stock. Investors and speculators offer more money to buy the stock and the price goes up.
However, whether the price continues to go up or not depends on how the company actually performs relative to expectations. With sky high expectations, the company really has to grow and do well to continue to draw in people willing to pay higher prices for the stock.
Flawed Reasoning
Section titled “Flawed Reasoning”Evaluating whether a stock is underpriced takes time and effort to understand the financial statements and the business. Therefore, people often use rely on their feelings without much deliberation or reasoning. “I like the company and so I like the idea of owning the stock.”
Lottery Stocks
Section titled “Lottery Stocks”If you do find a company and invest in it before the general public considers it a good company, then you can capitalize on that and potentially become very rich.
Many people find that this is easier said than done and the historical evidence confirms it
In the 2014 paper Betting against Beta or Demand for Lottery, the authors find that demand for lottery-like stocks leads to lower risk-adjusted returns. They define lottery stocks as “stocks with high probabilities of large short-term up moves in the stock price”
As John Bogle said, “Don’t look for the needle in the haystack. Just buy the haystack.”