When not to invest

Samuel Abisai, 28, was last week announced the winner of the SportPesa jackpot of Sh221 million. As expected, social media has been abuzz with what people would do if they won that much money.

I am unlikely to start betting, but I couldn’t help imagining what I’d do with this kind of money – including investing in the undervalued stock of a well-established and financially sound company that has a durable competitive advantage and a management with boundless integrity.

Unfortunately, many investors who are seduced by the false promise of easy money at the stock exchange try to become ‘active’ investors before they have the skills, resources or appropriate intellectual framework or information to do so.

Beating the market

This is not to say that investing in stocks is extraordinarily difficult – it is not. However, beating the market on a regular basis is far from easy and requires that an investor bring to the process a singular discipline, knowledge or passion that will allow him or her to rise above the crowd.

As Jason Zweig, a columnist for the Wall Street Journal, puts it: when possibility is in the room, probability goes out the window.

So, how can you tell if you are ready to become an active investor, and not just an investor who buys and sells stocks on a regular basis? And active in the way academics mean it – someone who selects their own stocks.

It’s not like there is a licensing process or anything. In fact, there is no formal course of instruction. Much like parenting, you tend to find out if you are cut out to be an investor only after you have made a pretty substantial commitment.

To save you the agony of wasting your time and money trying to figure out if you’re ready to invest in stocks, here are some pointers that indicate you should rethink the move:

1. If you need the money within two to three years at the least.

2. If you don’t like to do math.

3. If you use the word ‘play’, ‘gamble’ or any other speculation-oriented word when you describe your investments.

4. If you are unprepared for volatility. A lot of people look at the returns in the stock market only to turn pale at the first loss. If you cannot stand to lose money, you should not own stocks.

5. If you think you will only ever buy stocks that go up. News flash – you are not perfect, no system is perfect, no provider of advice is perfect. You can, and will, lose money at some point in your investment career. However, you can minimise these losses if you do your homework and are careful about valuations.

6. If you believe that share price movements alone tell you anything about the underlying quality of a company or its business. All too often, people buy low-priced shares with the idea that they are cheap, only to find out that they are low-priced because the underlying business is an empty shell.

7. If you couldn’t write down a list of why you bought a particular stock, and what might make you sell it. Bad scenario. Avoid it.

8. If you cannot tell the difference between a balance sheet and an income statement – especially if you don’t even know where to find a copy of either.

9. If you cannot make an educated guess on the underlying quality of a company.

10. If you cannot define any of the following words: gross margin, operating margin, profit margin, earnings per share, dilution, receivables, inventories, depreciation, amortisation, capital expenditure, market capitalisation, shareholder’s equity, return on equity.

11. If you cannot name the major products a company you’ve invested in makes, or the company’s major competitors.

12. If you don’t use the Internet to regularly refer to sites like wazua.co.ke or Young Nairobi Stocks Investors on Facebook. Almost all of the disadvantages on the information side of being an individual investor were erased by the Internet. You need to take advantage of the resources others are using.