The best way to lose money fast as a self-employed investor is to invest in companies you do not understand. The complexity of the company, your scope of expertise and your willingness to further analyze the company are all factors that should be considered when choosing a stock in which to invest.
The complexity of the company is inversely proportional to how close it is to your scope of expertise. No matter what, as complex as it may be, I believe that if you really want to and you take the time, you can understand any company. The problem is that time is limited and there is an infinite amount of companies available for analysis. It’s unrealistic to delve deeper into each one of them, so it’s a good idea to focus on those that you can easily and quickly understand.
For example, as an aerospace engineer, the mining industry with its explorations, core samples and soil composition science is not my forte. This reminds me of a company in which I invested: Sirios Resources. This company does mining exploration in James Bay. A few times a year it publishes the results of its prospecting samples and guess what? I have no idea what the results mean and what impact they could have on the stock or the company’s future. So, the company could announce almost anything and I would never really know if it’s good news or not. In this case, the stock has only fallen since I bought it and I can’t even tell you if it’s because of their sample results (which at first glance don’t seem too bad to me), because of the company itself, or because of the variation in the price of gold. So, to go back to my first article about stock market speculation, this was really speculation.
In addition to the complexity of the industry, there is the complexity of the company itself, and General Electric is a prime example. This company has become so diverse (aircraft engines, turbines, finance, appliances, lighting, etc.) that it becomes difficult to grasp and it is literally impossible to understand how external factors can impact this business.
In the 80s and 90s there was a tendency to diversify outrageously, but the trend has been the opposite in recent years. Today company’s aim to trim themselves down to their simplest forms or to their main business model. Google is another such example. It became difficult to understand their model, so they created the Alphabet entity, which clarifies the role of each business unit. Another example is Canadian National, a railway company. What was it doing in the hotel business with its Fairmont hotel chain? They have since separated from it. So there is a tendency to simplify, which makes the investor’s life much easier.
Why should you invest time to fully understand the company in which you want to invest? First, it helps you evaluate its risk. Knowing the risk will enable you to better make assumptions on future returns. It also helps you understand its business strategy that will point you to the relevant financial ratios to watch. In addition, understanding the company helps you evaluate the impact of world events, the market or the company on its future returns, and the risk of losing your hard-earned money.
Knowledge of a company is possible mainly through an internal evaluation (its strengths and weaknesses), an assessment of the industry in which it operates and, lastly, by looking at factors external to the company.
What I would like to do in my next few articles is to select a company and do an analysis of its internal and external environments. In my next article, I’m going to look at Dollarama, because it’s a relatively simple company: almost everyone has shopped there before! The stock has enjoyed strong performances for several years but is running out of steam, and everyone says it is overvalued. Together we will try to convince ourselves or refute this claim.