3 stock market myths that beginner investors should know about
Here are three stock market myths that beginner investors should know about. They sound plausible but can lead to trouble if taken too literally.
1: The stock market always goes up
Markets have historically risen over very long periods thanks to economic growth, technological innovation demographic shifts. But long periods where returns are flat or even negative happen too.
Crashes, corrections or bear markets are inevitable. Think about the time horizon and risk tolerance before assuming the market will keep rising in the short term.
2: Dividends are guaranteed
Dividend shares often get called âsafe betsâ for passive income because many companies have paid dividends year after year. But dividends are never set in stone. Companies can reduce or suspend them when profits shrink or during financial stress.
A high dividend yield can sometimes be a red flag signalling that earnings are not strong. Beginners should always weigh up dividend coverage, debt levels and cash flow rather than assuming a payout will be sustained forever.
3: Cheap stocks are better investments
A low share price or a low price-to-earnings (P/E) ratio doesnât always mean a bargain. Sometimes shares are cheap for a reason â weak earnings, declining industries or high debt burdens make them risky.
Meanwhile, some of the strongest long-term performers often trade at premium valuations because investors believe in their future growth. Check out fundamentals like revenue growth, return on equity (ROE), cash flow and competitive position instead of assuming that âcheapâ equals âgood valueâ.
One example: Barratt Redrow
Barratt Redrow (LSE: BTRW), the UK housebuilder formed by the merger of Barratt Developments and Redrow, illustrates how myths can mislead.
Recently, it missed its home sales guidance, selling 16,565 homes for the year ending June 29 — slightly below its April target of 16,800+. That triggered a share price drop of more than 10% in early trading.
Investors looking at its trailing price-to-earnings (P/E) ratio might find it high, at 36. But with earnings expected to grow, its forward P/E ratio’s closer to 10, suggesting it’s undervalued. Revenue growth’s modest but positive year on year in certain periods, and debt levels relative to cash assets are better than some competitors.
Still, Barratt Redrow faces risks such as sensitivity to mortgage rates and housing affordability. Most buyers need financing, so high interest rates hurt demand. Moreover, planning permissions, delays and cost inflation for materials can squeeze margins.
Because much of the companyâs revenue depends on consumer confidence and financing availability, interest rate cuts and an improving economy could lead to a significant recovery.
Subsequently, Barratt could still be a stock worth considering in the long term. But it serves as an example of how economic conditions can quickly change the narrative of promising income stocks.
Final thoughts
These three myths all have a grain of truth but none hold unconditionally. If growth expectations are baked in already or risks are under-appreciated, even a ‘cheap’ stock can disappoint.
So it’s important to weigh up each companyâs financial health, growth prospects and risk exposure before making decisions. To reduce risk, beginners should build a portfolio mixing growth and income stocks across sectors.
Itâs always better to check out the real story behind the numbers than to trust myths.
The post 3 stock market myths that beginner investors should know about appeared first on The Motley Fool UK.
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Mark Hartley has no position in any of the shares mentioned. The Motley Fool UK has recommended Barratt Redrow. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
