It is common for investors to make mistakes when apportioning capital. After all, there are an infinite number of factors that can affect a company's performance and share price. For example, weak operating conditions can cause profit warnings. Meanwhile, company management may make an acquisition that proves to be unsuccessful.
Even the most successful investors make mistakes when buying and selling stocks. Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) vice chairman Charlie Munger (Trades, Portfolio) recently discussed his shortcomings at the Daily Journal (DJCO, Financial) annual meeting. He stated:
"I'm constantly making mistakes where I can, in retrospect, realize that I should have decided differently. And I think that that is inevitable because it's difficult to be a good investor."
Overcoming mistakes
In my view, it is imperative for investors to not dwell on their mistakes. Otherwise, they may waste considerable amounts of time that can be better used to find buying opportunities and become a better investor. Munger went on to comment on this point in the Daily Journal meeting. He said:
"I'm pretty easy on myself these days. I'm satisfied with the way things have worked out and I'm not gnashing my teeth when other people are doing better."
Instead of dwelling on mistakes, taking some time to learn from them could be a more productive use of time. For example, an investor may have failed to check specific ratios when analyzing a company's balance sheet that would have highlighted its financial fragility. Or, they may have accepted a valuation that is too high relative to its sector peers.
Learning from these types of errors reduces the chances of them taking place again. It may also improve an investor's ability to identify attractive buying opportunities, while avoiding those stocks that could potentially provide disappointing returns.
An investment checklist
Munger also commented on the importance of having an investment checklist that is used before buying any stock. He stated:
"I think that the methods that I've used including the checklists are the correct methods and I'm grateful that I found them as early as I did and that the methods have worked as well as they have. I recommend that other people follow my example."
In my view, an investment checklist will help to reduce the volume and severity of mistakes made when buying stocks. It will force an investor to consider a wide range of specific factors before purchasing a company. The checklist can evolve over time to include new areas where an investor has previously made mistakes. This could further reduce the chances of them recurring in future.
An investment checklist may be particularly useful at the present time. The bull market means that investor sentiment is upbeat. This may be conducive to greater risk taking that means investors are less disciplined when analyzing a stock's fundamentals and valuation. An investment checklist may aid this process because it places definitive limits on what is required from a stock to merit purchase.
In addition, it may be prudent to use an investment checklist to reassess existing holdings. Many companies have experienced rising stock prices in recent months. Re-analyzing them using an investment checklist now that they trade at higher prices may flag some holdings as being unattractive based on their lack of a margin of safety. This could prompt an investor to sell them to avoid making the mistake of anticipating that the current bull market will last in perpetuity.
Disclosure: The author has no position in any stocks mentioned.
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