In some ways, public markets have become a lot safer to invest in over the last century. Regulators now mandate quarterly financial disclosures and earnings announcements in most developed countries. The average investor now has more access to information than ever before. This is a real change in financial history. When Benjamin Graham, was is considered to be the father of value investing, was writing "Security Analysis," the prevailing view was that no prudent investor should invest in common stocks. Why would you risk your hard-earned money on a security that offers no legal guarantee of a future payment stream (like a bond does), especially when there's a chance that the whole venture is fraudulent?
Nowadays of course, things are much different. Most average investors prefer to put their money in stocks. Warren Buffett (Trades, Portfolio), one of the most successful investors of all time, routinely states that stocks outperform bonds over the long term (and this has been confirmed by many studies). On the other hand, investor psychology really doesn't change that much. Fraudsters will always exist and prey upon the constants that are human naivete and greed. So here is a tip to bear in mind so that you don't get sucked in by the frauds of the world.
Compare companies to peers
Everyone wants to own the best business in a given industry, and there's nothing wrong with this. However, this desire can sometimes blind investors to the realities of business. This tendency to turn a blind eye to possible frauds is most pronounced in newer, more complex sectors, such as biotechnology, green energy or aerospace.
Most retail investors lack the expertise required to adequately assess companies in these spaces, but many are still lured in by the promise of "the next big thing." A prime example of this is asteroid mining - a number of such ventures have begun to raise capital, despite the fact that most serious astrophysicists and aerospace engineers agree that it cannot (at present) be financially viable to mine asteroids.
But even in more traditional sectors, it is easy to be seduced by companies that seem to be trouncing the competition. It's nice to own an outperforming auto manufacturing company with excellent financials, but is it really likely that they are that much better than the likes of Ford (F, Financial) or General Motors (GM, Financial)? This is what investors in Nikola (NKLA, Financial) have come to realize - it is simply not realistic to expect a company with no experience and comparatively little spent on research and development to do much better than industry leaders who spend billions of dollars every year to make incremental improvements to existing technologies. As the saying goes: "When something seems too good to be true, it probably is."
Disclosure: The author owns no stocks mentioned.
Read more here:
- Warren Buffett: The Advantages of Investing in Small Companies​
- Market Indicators Off of the Beaten Path
- Warren Buffett: The Rationale for Issuing Preferred Stock
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