In the dinosaur saga “Jurassic Park,” author Michael Crichton wrote about a man who believed
a tyrannosaurus couldn’t see him if he held still. The carnivore ate him.Later in the book,
someone asks what killed the man. Another character answers, “He was misinformed.”Misinformation
can be costly. Here are 10 notions that lead investors astray.
Myth No. 1: The best companies make the best stocks.
Stocks advance when a company exceeds prevailing expectations.The bestcompanies usually generate
lofty hopes among investors, which are hard to exceed.
I began writing about stocks in 1972, when the “Nifty Fifty” stocks were all the rage. Companies such as
International Business Machines Corp., McDonald’s Corp. and Xerox Corp. were so universally beloved that investors happily
paid 60 times earnings to own them.
These were indeed good companies: Their earnings continued to climb strongly for a decade or more. Yet they were bad
stocks, because people overpaid for their anticipated success.Today’s equivalent in my opinion is Apple Inc. The
Cupertino, California, maker of iMacs, iPhones and iPods is highly profitable, debt-free, and held in universal awe. That’s
why shares sell for 32 times earnings, more than six times book value and almost five times revenue.
Apple is a great company. But I predict that over the next two years it will be only an average stock.
Trading Costs
Myth No. 2: In today’s volatile markets, one must be an active trader.
Before you are tempted to believe this, consider commissions and taxes. The commissions are not too bad these days, now that discount brokerage is routine.
Taxes are nasty, though. Long-term capital gains are taxed at 15 percent, short-term gains at up to 33 percent. You have to be pretty arrogant to disregard that cost.
Myth No. 3: Analysts are a good guide to picking stocks.
Analysts are intelligent, know a company’s managers better than you ever will, work long hours, and have a staff of young,hard-charging assistants.
None of that necessarily makes them standouts at picking stocks. In my ongoing study, now at 10 years and counting, analysts’ most-favored stocks underperform the Standard & Poor’s
500 Index. I think analysts tend to fall for Myth No. 1.
Don’t Fear October
Myth No. 4: Beware of October, the killer month for stocks.
The worst month for the markets is September, not October. According to Ned Davis Research, the average monthly price change for the Dow Jones Industrial Average in September since
1900 has been a loss of 1.1 percent.
February and May also show small losses, on average. October, with an average gain of 0.1 percent, is the fourth worst month. Admittedly, October has seen more than its share of
stock market crashes, but there have also been plenty of robust Octobers.The best months, incidentally, are December (average gain 1.5 percent), July (1.3 percent) and April (1.2 percent).
Presidential Preferences
Myth No. 5: You can count on the U.S. presidential cycle to predict the market.
Sorry, Charlie, but the stock market has precious few things one can count on. In general, the first year of a president’s term is the weakest for stocks, and the third year
is strongest. The second and fourth years tend to be average.
The key phrase is “tend to.” According to presidential cycle lore, 2008 should have been a normal year, yet the S&P 500 fell 37 percent (including dividends). This year should be sub-
par, yet the S&P 500 has risen 13.5 percent.
Myth No. 6: Price-to-earnings ratios are the perfect measure of a stock’s value.
I probably love P/E ratios as much as anyone. Yet they are neither a perfect measure nor a magic shortcut to stock picking.For example, Ford Motor Co. earned $1.20 a share in 2005.
At the end of that year the stock was selling for about $8 a share, so the P/E ratio was attractive at about six. A winsome P/E, however, didn’t stop Ford from losing money
in each of the next three years. And it didn’t stop the stock from falling to $2.29 at the end of 2008.
No single measure tells you everything you need to know.
Malkiel’s Advice
Myth No. 7: Stocks should be bought when they have momentum.
Many respected market participants hold this belief. Perhaps foremost is William O’Neil, publisher of Investors Business Daily.I tend to side with Burton Malkiel, a Princeton economics
professor who argues that the benefits of using relative strength are canceled out by the increased trading costs involved in using this strategy. Momentum investing works some
of the time, but in my judgment it doesn’t work consistently. In addition, it is a tax-inefficient strategy because it often generates short-term gains.
Myth No. 8: War is good for the stock market.
Because spending on World War II helped pull the U.S. out of the Great Depression, many people think rising military spending correlates with a rising market. It’s often untrue. The
market made little headway in the 1970s, when the Vietnam War raged. It boomed during the 1980s, a time of relative peace.
Party Favors
Myth No. 9: The market prefers Republicans.
According to Ned Davis Research, the annual gain in the Dow average was 7.2 percent under Democratic presidents from March 4, 1901, through July 8, 2008.
It was only 3.6 percent under Republicans during the same period.
The best stock-market performance on record so far was logged under Bill Clinton, a Democrat.
Myth No. 10: Market timing can greatly enhance your returns.
It could, if one could do it accurately. However, successful market timers are rarer than scrawny sumo wrestlers. Most people who try to time the market end up being on the
sidelines during the unexpected sudden upturns that account for a significant part of the market’s long-term gains -- this spring’s rally, for example.
a tyrannosaurus couldn’t see him if he held still. The carnivore ate him.Later in the book,
someone asks what killed the man. Another character answers, “He was misinformed.”Misinformation
can be costly. Here are 10 notions that lead investors astray.
Myth No. 1: The best companies make the best stocks.
Stocks advance when a company exceeds prevailing expectations.The bestcompanies usually generate
lofty hopes among investors, which are hard to exceed.
I began writing about stocks in 1972, when the “Nifty Fifty” stocks were all the rage. Companies such as
International Business Machines Corp., McDonald’s Corp. and Xerox Corp. were so universally beloved that investors happily
paid 60 times earnings to own them.
These were indeed good companies: Their earnings continued to climb strongly for a decade or more. Yet they were bad
stocks, because people overpaid for their anticipated success.Today’s equivalent in my opinion is Apple Inc. The
Cupertino, California, maker of iMacs, iPhones and iPods is highly profitable, debt-free, and held in universal awe. That’s
why shares sell for 32 times earnings, more than six times book value and almost five times revenue.
Apple is a great company. But I predict that over the next two years it will be only an average stock.
Trading Costs
Myth No. 2: In today’s volatile markets, one must be an active trader.
Before you are tempted to believe this, consider commissions and taxes. The commissions are not too bad these days, now that discount brokerage is routine.
Taxes are nasty, though. Long-term capital gains are taxed at 15 percent, short-term gains at up to 33 percent. You have to be pretty arrogant to disregard that cost.
Myth No. 3: Analysts are a good guide to picking stocks.
Analysts are intelligent, know a company’s managers better than you ever will, work long hours, and have a staff of young,hard-charging assistants.
None of that necessarily makes them standouts at picking stocks. In my ongoing study, now at 10 years and counting, analysts’ most-favored stocks underperform the Standard & Poor’s
500 Index. I think analysts tend to fall for Myth No. 1.
Don’t Fear October
Myth No. 4: Beware of October, the killer month for stocks.
The worst month for the markets is September, not October. According to Ned Davis Research, the average monthly price change for the Dow Jones Industrial Average in September since
1900 has been a loss of 1.1 percent.
February and May also show small losses, on average. October, with an average gain of 0.1 percent, is the fourth worst month. Admittedly, October has seen more than its share of
stock market crashes, but there have also been plenty of robust Octobers.The best months, incidentally, are December (average gain 1.5 percent), July (1.3 percent) and April (1.2 percent).
Presidential Preferences
Myth No. 5: You can count on the U.S. presidential cycle to predict the market.
Sorry, Charlie, but the stock market has precious few things one can count on. In general, the first year of a president’s term is the weakest for stocks, and the third year
is strongest. The second and fourth years tend to be average.
The key phrase is “tend to.” According to presidential cycle lore, 2008 should have been a normal year, yet the S&P 500 fell 37 percent (including dividends). This year should be sub-
par, yet the S&P 500 has risen 13.5 percent.
Myth No. 6: Price-to-earnings ratios are the perfect measure of a stock’s value.
I probably love P/E ratios as much as anyone. Yet they are neither a perfect measure nor a magic shortcut to stock picking.For example, Ford Motor Co. earned $1.20 a share in 2005.
At the end of that year the stock was selling for about $8 a share, so the P/E ratio was attractive at about six. A winsome P/E, however, didn’t stop Ford from losing money
in each of the next three years. And it didn’t stop the stock from falling to $2.29 at the end of 2008.
No single measure tells you everything you need to know.
Malkiel’s Advice
Myth No. 7: Stocks should be bought when they have momentum.
Many respected market participants hold this belief. Perhaps foremost is William O’Neil, publisher of Investors Business Daily.I tend to side with Burton Malkiel, a Princeton economics
professor who argues that the benefits of using relative strength are canceled out by the increased trading costs involved in using this strategy. Momentum investing works some
of the time, but in my judgment it doesn’t work consistently. In addition, it is a tax-inefficient strategy because it often generates short-term gains.
Myth No. 8: War is good for the stock market.
Because spending on World War II helped pull the U.S. out of the Great Depression, many people think rising military spending correlates with a rising market. It’s often untrue. The
market made little headway in the 1970s, when the Vietnam War raged. It boomed during the 1980s, a time of relative peace.
Party Favors
Myth No. 9: The market prefers Republicans.
According to Ned Davis Research, the annual gain in the Dow average was 7.2 percent under Democratic presidents from March 4, 1901, through July 8, 2008.
It was only 3.6 percent under Republicans during the same period.
The best stock-market performance on record so far was logged under Bill Clinton, a Democrat.
Myth No. 10: Market timing can greatly enhance your returns.
It could, if one could do it accurately. However, successful market timers are rarer than scrawny sumo wrestlers. Most people who try to time the market end up being on the
sidelines during the unexpected sudden upturns that account for a significant part of the market’s long-term gains -- this spring’s rally, for example.
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