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Debunking common investment myths
Just because it sounds cool, doesn't mean it's a good investment

Investors spread myths about ways to invest successfully every day. Whether it's the hot stock tip received from an accountant or entrepreneur, or the IPO that your broker is letting you participate in, it's important for investors to separate sex appeal from investment merit. Contrary to popular belief, the two often don't go hand-in-hand. Hence, this week, the focus will be on giving you the low down on today's most popular misconceptions.

"My employer is letting me buy its shares prior to its IPO. I don't want to miss out on that opportunity."

It's often not a good idea to buy stock in your employer, for a few reasons. The first reason is diversification. Working full time for one employer already makes your entire income dependent on this one company. While it may be a decent idea to buy small amounts of company stock, particularly if it's subsidized, it's still not prudent to excessively exposure your financial well-being to your employer's stocks, purely from a diversification standpoint.

The second reason has to do with investment merit. While employers may make employee purchase plans attractive, by allowing discounted purchases or matching plans, investors must do their best to take an objective look at what they're buying. In other words, if a stock is grossly overvalued - admittedly not an easy assessment to make - no matching plan or employer discount will make buying the stock a worthwhile venture.

Finally, investors would be well advised to stay away from most IPOs (initial public offerings). An IPO marks the trading debut of a company's shares on the public markets, like the Toronto Stock Exchange. It's really a company's way of raising money to finance its future growth. It raises money by selling small pieces of ownership - its shares - in its equity. When launching an IPO, a company will want to raise as much money as possible, while minimizing the number of shares they have to sell.

If a company is selling its shares in an attempt to fetch top dollar, that may be a sign that it's a bad time to buy those shares. Think about it. A company hires investment bankers to help decide how many shares to sell, how to structure it, what price to set, and when to launch the IPO. IPOs are often delayed when stock markets hit the skids because a company wouldn't be able to raise as much money when share prices are down, overall. They wait until market conditions improve (i.e. prices rise) before proceeding.

"What do you mean it's not a good investment? An industry leader is a great company and a safer investment than some unknown."

While this statement makes intuitive sense, there are times when it couldn't be further from the truth. Not to pick on the obvious example, but Cisco Systems epitomizes how good companies can be bad investments. Cisco was an industry leader during the peak of the technology boom. Despite the fact that a global economic slowdown has crippled the industry in which it resides, Cisco remains in its enviable competitive position. So what has happened to its share price? Over the past two years, the stock has fallen by nearly 60 per cent, and has been flat over the last three years. That's not exactly the type of stellar performance most investors expect from industry leaders. I'm not commenting on its future potential, but simply illustrating what can happen.

The lesson to be learned from Cisco, and many other similar stories, is that every stock - no matter how good the underlying business - has a limit to what it's worth. Drivers who love their Cadillac luxury vehicles are obviously willing to ante up the $60,000 needed to buy a DeVille. How many Cadillac lovers would be willing to pay $80,000 or $100,000 for the same car? Not many I'm guessing.

This is a more simplistic example because buyers know the manufacturer's listed price is the high end. But with a stock, it's much tougher to assess a value. And that's the major mistake most investors make with "good companies". They either lack the skills or time needed to value a stock, so they assume it's good value at any price - particularly if it's just fallen in price.

Paying an excessive price is speculation, no matter what the company.

"Boring companies aren't worth my investment dollars. I want to invest in leading edge technology - in companies that will change the way we live and work. Now, that's an exciting investment."

What would you say if I told you that a couple of this country's best money managers are buzzing about a company that converts and markets packaging products? Boring, right? What if I told you that same company has seen its earnings per share grow by 78 per cent per year over the past two years but trades at just 7 times its latest earnings and below its book value? I can't tell you the name of the company because this information is very incomplete. However, my point is to illustrate that companies that sound boring on the surface may in fact offer exciting investment opportunities.

Marketing departments and corporate spin-doctors heavily cloud the streets of Bay and Wall. Successful investing is about cutting through the fluff and getting to the real heart of any investment. It's not about buying into a concept that sounds cool or cutting edge; it's about investing in what makes sense and about paying attention to how much your paying for a company's future expectations.

This is most applicable to individual stock investing, but can also be applied to the ever-growing universe of specialty mutual funds. Investors who are disciplined and insightful enough to see through the fluff should be successful in their investment endeavours.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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