Wall Street myths: a half-truth can be investor's undoing
Wall Street is full of myths that periodically need debunking. You've all heard ''you'll never go broke taking a profit.'' On the face of it, you won't, if your motive is to avoid going broke. But the goal of investing shouldn't be the avoidance of bankruptcy. Instead your objective should be to maximize your capital and the income that capital can produce.
''In war, there is no substitute for victory,'' said Gen. Douglas MacArthur. In investing, there's no substitute for making a lot of money. The defect of the above slogan is that taking a small profit may prevent you from enjoying a much larger one down the road. The trick is in sensing how long to let your profits run. Selling Digital Equipment or Wang Laboratories after doubling your money 10 years ago was no substitute for the far greater gains that followed.
Then there is the thought that you can't lose much in a low-priced stock. ''It's only 21/2, so it can't go down much more,'' you may tell yourself. Baloney! You can always lose 100 percent of your investment, if things are bad enough. You can do just as badly in a $50 stock as in a $5 stock (or just as well, for that matter).
The other side of this counterfeit coin is the notion that low-priced stocks will go up more than high-priced stocks. This contention is equally false. What makes stocks go up or down is a host of factors, including the changes in earning power and dividends together with how Wall Street perceives them. Low prices are irrelevant.
But wouldn't it be a good idea to buy a stock that is about to be split? Or, even better, before the announcement?
This argument is harder to win, since stock splits tend to be synonymous with success. The stock of a company that grows and prospers is likely to rise in price over time. Since the public has an aversion for buying high-priced stocks, directors vote to split the stock to bring the price into a more popular range.
The act of splitting the stock and multiplying the number of shares outstanding, with a corresponding reduction in price, does nothing to change the intrinsic value of the investment. But since stock splits tend to be associated with successful companies, they're popular with the public. By themselves, they do nothing for the shareholders except to make happy the more gullible shareholder and create paperwork.
Suppose you bought a 30-year bond carrying a 5 percent coupon years ago when interest rates were low. Today it's selling at 50 cents on the dollar. ''But I'm still getting a good income and it'll go back to 100 when it matures,'' you might say.
This consolation is scant help; the truth is that you've lost half of your investment and that you didn't anticipate the big rise in interest rates. Protection and enhancement of capital are the name of the game. Income is a welcome byproduct. It can be devastating to a bond portfolio of long maturities when interest rates rise. Ask any banker or insurance company executive.
''High-yielding stocks are safer investments than low-yielding stocks.'' This is another bit of folklore. There's a difference between the amount of dividend a company pays and the resulting yield to the investor - that is, the dividend divided by the price. This is often a warning that trouble may lie ahead, that the dividend may not be maintained.
Just as bond yields inversely reflect bond quality, stock yields do too. You're better off to choose stocks primarily for their potential for growth and to accept a more modest income. It's rare to find high-yielding stocks that can double or triple. But certain Boston bank stocks did this within the last five years.
Then there's the argument that announcement of bad news (Tylenol and Johnson & Johnson) is good reason to sell the stock. A great idea if you could sell before the announcement, for bad news does indeed depress the price. The trouble is that panic selling is often done at distressed prices. Later, when analysts have had time to assess the possible damage, more often than not, the price is on the way up. Some very smart money went into American Express at the time of the salad oil scandal and into Bank of Boston during the Falkland Islands crisis.
As for buying on good news, be sure to study the price trend of the stock before you act. Often it's already built into the price.
Myths and old wives' tales abound in the world we live in and Wall Street has its share. Learning to recognize them can help put your investments in the win column.