If Investing Feels Like Gambling, You're Doing It Wrong
Investing is not about luck, it is about knowing what you are buying
Many people invest in the stock market without having done the required research beforehand. They buy shares of a company expecting them to only go up —and fast.
However, what happens when the price of the shares suddenly falls and doesn’t go up as expected? People start feeling they made a mistake, they lost money and don’t understand why. It’s like gambling in a casino where the outcome is only bound to luck.
In fact, they are absolutely right. They usually lose money because they don’t know what they’re doing. When someone does not know what he is doing, investing in the stock market is like gambling. Buying securities we don’t understand is taking a huge risk of permanent loss of capital —like playing roulette.
Why it should not feel like gambling
The stock market is not a gambling parlour. The stock market is where you buy pieces of companies.
When people buy shares of a company they forget their investment future results are not dependent on what the share prices of a company will do in the next year or two. This mindset is completely wrong and is why investing feels like gambling when share prices don’t go up.
Our investment results depend solely on the company’s performance. If the company is doing well, the stock price will eventually reflect that.
Therefore, if we know that the company is doing well, why would we care about a sudden drop in the share price? We should not, because this is not a casino.
Knowing what you own
When you have a strong conviction about the company you invested in and it’s backed up by facts, numbers and evidence, you won’t feel like you are gambling when the shares of the company go down.
Let’s say you own a great company like Microsoft. You know the company very well, you know how incredibly efficient in terms of capital generation and allocation it is, and you also know they have a powerful moat (durable competitive advantage): Microsoft Office.
Microsoft Office is such a powerful moat because it cannot be displaced. There is no way another company will develop an Office-like suite to compete against Microsoft in the short term. It is a monopoly, and it will be for the next 10 years at least.
Why is it a strong moat? Because all big enterprises —and small ones too— use Microsoft Office, more specifically Excel, Word and Power Point. For a large company, the cost and the hassle to change to another suite would be too high —and there is no real competitor to go to.
If you deeply know the strengths of the company and you can foresee its future (based on facts), you won’t feel like you are gambling when the stock market drops.
What to do before investing in a company
Before you put any money into a company you should ensure you understand the company well. What does it mean?
Understanding a company means understanding its business model, financials, management team and competitors. That way, you can forecast with quite a bit of accuracy what the company's future will be. Hence, investing won’t feel like gambling.
Lastly, you don’t want to overpay for a company, even if it is a marvellous company one can pay too much for it. You need to calculate what the intrinsic value (what the company is truly worth) of a company is and only buy into it when the price is below that point. Remember that, in the end, investing is buying a dollar bill for less than a dollar.
If you look at the graph above you’ll see that the share price (green line) doesn’t always follow the intrinsic value (orange line).
The key is to buy shares when the company is underpriced —when the share price is below the company’s intrinsic value.