The Most Important Stock Investment Lesson I Ever Learned

My investing career officially started in 1970. However, for several years prior to that time I was an avid and interested student of common stock investing. My initial lessons were taught by studying the behavior and practices of the most renowned stock investors. Although these academic pursuits taught me a great deal, nothing taught me more than the school of hard knocks. Consequently, the most important lessons I learned were unmercifully taught through real-life experiences. Some of these lessons were hard and even cruel at times. But the hardest lessons learned are often learned best.

The theme of this article is to share with my readers what I consider to be the most important stock investment lesson I ever learned. This important lesson is supported by virtually every master investor that I have learned to respect and admire. This lesson was also emphatically taught to me in the school of hard knocks. However, my motivation to write this is born from the realization that very few “investors” are able to implement this lesson under real-world situations. My anecdotal evidence for this fact stems from the litany of comments I often receive on my articles, as well as numerous discussions with clients over the years.

Additionally, I write this fully cognizant of the reality that very few will be psychologically capable or even willing to heed this important lesson. With that said, this important lesson is actually quite simple even though it is difficult for many investors to embrace and practice. However, if this message resonates with just one reader, then I will feel that my efforts were worthwhile.

The Most Important Stock Investment Lesson I Ever Learned

From a broad or general perspective, this investment lesson is simply to apply the discipline to only take investment advice from credible sources. Unfortunately, it has been my experience that most investors are keen to get their investment advice from pathological liars. Obviously, pathological liars are not a reliable source.

More specifically, this important investment lesson is: do not base investment decisions on stocks based on short-term price volatility. Truly aware investors recognize and accept the reality that stock price movements can be, and often are, irrational in the short run.

Furthermore, I’ve written extensively on the subject in the past. On February 9, 2013 I posted an article titled “How To Properly Think About Stock Prices In Today’s Volatile Markets” Originally, I intended to title the article “Stock Prices Are Pathological Liars.” However, upon further reflection I was afraid the title might be too provocative. Readers interested in learning more about the most important investment lesson I ever learned might enjoy reading that article as I consider the message timeless. Nevertheless, this speaks to my pathological liar comment referenced above. What follows is my opening paragraph:

“Price volatility is an unavoidable aspect of investing in common stocks. During periods when emotions are dominating reason, price volatility can become more pronounced than is normal during calmer times. The insidious part of this fact is that the more volatile stock prices are, the more fear and stress they generate, which only feeds even greater volatility. Of course, the same can be said when greed raises its ugly head. The purpose of this article is to provide some logic and reason that can be applied to stock price volatility that simultaneously weakens its potential damage.”

Price Is What You Pay-Value Is What You Get

Investing wisdom states that the price is what you pay, but the value is what you get. Therefore, determining value is vital to successful investing. As I have stated many times before, value is derived from the future cash flows your investments generate relative to what you pay to buy them. The important point is that value is a relative term.

Investors often rely on calculations such as price to earnings ratios (PE ratios) to ascertain valuation. Unfortunately two companies with the same PE ratio can have entirely different true values. Even more dangerous is the fact that a company with a lower PE ratio could actually be much more expensive than a company with a much higher ratio. It’s all relative to the company’s future cash flow/earnings generation.