Humans are all emotional beings. We do not always make decisions rationally. Investors might feel better towards stocks at a certain point, or they might think that owning stocks is risky and avoid it at all cost.
Investors may also feel attached to a specific company and continue owning the stock without regard to its fundamentals. 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 good that, buying the stock will give you profit, right? Wrong. Now, we’re 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 emotions for a second and think clearly. Sure, you’d like to have a Mercedes in your life. It is luxurious and has a lot more fancy features than a Civic has. However, that does not mean you should overpay for it. It works similarly with stock investing.
Google is a good search engine, the best out there. Sure, you probably pay more for Google (stock) than other generic search engines. But, please don’t overpay. 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 eradicate it, but specific tools might help. One is to calculate the fair value of a common stock that you are investing in. 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 as big as Google, you can incorporate its growth and calculate the fair value with growth.
Emotion is hard to ignore. However, following your emotion will cost you 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 well.
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