Humans are all emotional being. We do not always make decisions rationally. Emotion is part of us as investors. Investors might feel better towards stocks at certain point or they might feel that owning stocks are risky and avoid it at all cost.
Investors may also feel attached towards a specific company and continue owning the stock without regards to its fundamental. For example, you might like Google’s search engine so much that you decide to buy the stock at $ 350 without doing any research. You figure that Google’s search engine is so much better that buying the stock will give you profit, right? Wrong. Now, I am not here to bash Google as an investment, but analyzing an investment goes beyond the products and companies. Most investors can identify good companies and products. It is quite easy. You know that a Mercedes is a better car than a Ford or a Civic.
The next question is how much should you pay for a Mercedes or a Civic? This requires us to put aside our emotion for a second and think clearly. Sure, you’d like to have a Mercedes in your life. It is luxurious and have a lot more fancy features than a Civic has. But, that does not mean you should overpay for it. It works similar with stock investing.
Google is a good search engine, probably the best that is ever produced so far. Sure, you probably pay more for Google than other generic search engines. But, please don’t over pay. You invest in Google to profit from it not because you like its products.
So, how do we eliminate emotion from our investing decision? We can’t eliminate it completely but there are certainly tools that might help. One is to calculate the fair value of a common stock that you are investing in. I covered this plenty of times but basically, the fair value of an investment is dependent upon the streams of profit generated by it. In the long run, if company A earns more than company B, then company A will be valued more than company B.
For a company that is growing such as Google, you can incorporate its growth and calculate the fair value with growth. I have talked about this once and you are welcomed to check our commentary section.
I know I don’t exactly give you the best solution to the problem. Emotion is hard to ignore. I am not immune to that. But following your emotion will cost you a lot of money. Just watch those investors that bought during the NASDAQ peak in 2000. Don’t follow the herd and keep your focus on the fair value of your stock. You will do really really well.