Each and every hour, we make decisions.
Fortunately, most of those don’t have long-term consequences, so a poor choice won’t wreck your life.
For example, selecting which flavour of ice cream to have.
“The cost of a poor decision in ice-cream decision making is non-substantial, and so, most people don’t give it more than a second thought,” Collins St Value Fund managing director Michael Goldberg posted on Livewire.
“In fact, most choices that people make on a day to day basis don’t have a high cost, and so many people get comfortable with ‘going with their gut’.”
However, this approach could have dire consequences for investments.
The role of emotion in investments
According to Goldberg, each decision in our lives is decided with a combination of emotion, intellect and circumstance.
This is not to say you should force yourself to completely eliminate emotion when making decisions about buying, holding or selling shares.
“Recognise that emotions play a part in decision making, and use them to your benefit,” he said.
“We can’t expect to disconnect ourselves entirely from the impact of emotions when making investment decisions, but we can put in place a process that ensures that we are not driven by them.”
Goldberg recommended four steps to take in order to achieve the right balance between emotion, intellect and circumstance when making investment decisions:
1. Decide the value of the company
It might seem obvious, but in a bull market, an investor can lose sight of a company’s “intrinsic value” said Goldberg.
“In a world (market) so dominated by emotion, fads, and talking heads, the only factor we can truly control is the price we are prepared to pay or sell at. To establish those points, the starting point must always be ‘what’s it actually worth’.”
There is currently much talk about growth vs value, momentum vs fundamentals, quantitative vs qualitative analysis.
According to Goldberg, all that is unnecessary noise and the only two questions that matter for a particular share are: What are the company’s earnings and what am I prepared to pay for those earnings.
“Ignoring either of those fundamental questions leads to some interesting, and often scary situations.”
The enthusiasm for technology companies that have never made a profit is the classic symptom of ignoring these basic questions, said Goldberg.
“Even with companies like Xero Limited (ASX: XRO) and Afterpay Ltd (ASX: APT), which may at some point become worth the market cap they now demand, investors really need to ask themselves if they are investing in the businesses or speculating on the share price.
“Understanding the difference between the two and being able to identify which you are doing is absolutely essential for long term peace of mind (and fortunes).”
2. Talk to someone
Goldberg recommended having a friend to talk to who won’t be afraid to slap you in the face when you’re about to act against your own interests.
“Being able to avoid the trappings of falling in love with an idea, a company, or a way of thinking is absolutely essential to long term results,” he said.
“If you aren’t constantly and independently challenging your assumptions, chances are you’ve already fallen into the trap of group think or bias.”
3. Ignore the market
This is somewhat related to the first step of not listening to “the noise”.
According to Goldberg, too much value is placed on the movements of the indices such as S&P/ASX 200 Index (ASX: XJO).
“It is simply the whim of some 5 million investors, each of whom are making decisions on individual companies based on how they felt when they woke up that morning,” he said.
“The magnitude of the misplaced value ascribed to the ‘all powerful’, ‘all knowing’ market is highlighted by the significant differences of the companies that make up the indices.”
Goldberg prefers to think of the ASX as “a market of stocks” rather than the “stock market”.
“To suggest that [companies] like Telstra Corporation Ltd (ASX: TLS), Commonwealth Bank of Australia (ASX: CBA) and BHP Group Ltd (ASX: BHP) are somehow intrinsically connected is patently silly,” he said.
“Each is driven by distinctly different factors, and very few (if any) intersect. Yet, when we quote ‘the market’, we do so as if it were a singularity, connecting each of the companies that make up the index as if they were all driven in the same direction by the same drivers.”
If you’re an investor and not a speculator, there is no need to play the mug’s game of guessing whether markets will rise or fall.
“Our job as investors is to simply understand the businesses we are considering, identify if they are cheap or expensive, and on that basis buy or sell,” said Goldberg.
“Everything else is a distraction.”
4. Pull the trigger
You’ve done all the research about what the company is earning and how much you’re willing to pay.
But sometimes actually converting all that hard work into real action is the most difficult step.
“This is especially so in times of extreme conditions,” said Goldberg.
“Extreme conditions create the most attractive investing opportunities, with some 90% of market returns being earned over just 5% of trading days.”
Goldberg quoted US motivational speaker Eric Thomas: “Everyone wants to be a beast until it’s time to do what beasts do.”
Feeling uncomfortable is part of the investment process.
“It’s precisely during those times that all those around you think you are crazy, when even your ‘gut’ insists that you’re making a mistake that true long term profits are established,” he said.
“It’s in recognising that discomfort and realising that therein lies the opportunities that the greatest investors make the most spectacular returns.”
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Motley Fool contributor Tony Yoo owns shares of AFTERPAY T FPO and Xero. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia owns shares of AFTERPAY T FPO and Xero. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
The post 4 steps to pick winning ASX shares appeared first on The Motley Fool Australia.
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