Peruse your favorite financial news website for updates on a stock in your portfolio and you’ll no doubt encounter dozens of headlines offering all sorts of articles and information. Expand your search to the broader worldwide web and you’ll quickly discover thousands of links with an endless supply of facts, opinions, and recommendations published on websites and discussion forums. Taking the time to review even a small subset of available content about any particular company could take years.
For individual investors, the key to making sense of all the information that’s available about a stock is to develop the skill of differentiating news from noise.
While news comes in many varieties, noise is any data that isn’t relevant to your personal investing approach. Eliminate noise, and what’s left is the information that’s pertinent to your investment research and can assist you in decision-making.
Noise comes in several flavors. Turn on any financial television program and you’ll hear plenty of commentary and advice that simply is not relevant to your investing style. No matter whether you’re a trader or a buy-and-hold investor; or an investor in ETFs, individual stocks, currencies, or precious metals; or are a retiree or still in the capital accumulation stage of your life, not everything is important.
For instance, rising inflation might affect decisions about stocks in the short-term, but won’t likely have a big impact on stocks that you intend to hold for five or ten years. The strength or weakness of the U.S. dollar might drive changes in a portfolio of international ETFs, but tends to balance out over time in a broad portfolio of high-quality growth stocks.
Noise can also be identified when reviewing individual company metrics. A typical financial analysis college textbook might contain hundreds of financial ratios that can be used to analyze a company’s business. Many of them are industry-specific, while others are useful in identifying weaknesses in troubled enterprises.
If you were to apply every ratio in the book to every company, you would be unlikely to find any company that appeared acceptable (and if you did, you’d probably suspect some accounting shenanigans in the company’s reported financials).
In terms of the fundamental approach to long-term focused growth stock selection that we utilize in the SmallCap Informer the subset of information that informs the bulk of our analysis can be explained in two or three pages of text. Subsequent quarterly or annual updates are covered in a few paragraphs.
Beyond that, other news is assessed by determining its likely impact on a company’s long-term fundamental performance. Facts with no or minimal impact on how a company might end the next half-decade should be delegated to the circular noise file.
It might seem like we’re taking shortcuts in our company analysis, but due to the interconnected nature of many of the figures on a financial statement, companies that stand above the crowd in a few select metrics will tend to also rank above-average in many others. Reviewing all of the data points is simply not an efficient way of analyzing a company’s fundamentals. It is rare that a red flag raised in one of the secondary analysis metrics reveals a much larger problem or reveals the problem much sooner than otherwise would have been uncovered.
This doesn’t mean that we should ignore bad news about the companies that we follow. In fact, one of the cognitive biases of which investors should be aware is the tendency for our brains to ignore negative news or facts that don’t support our starting premise.
With experience, investors learn how to interpret bad news and how not to panic. Acting on noise, especially from a position of uncertainty, is one of the fastest ways to give up gains in a portfolio or inhibit a portfolio’s potential performance.
Learning how to invest in the stock market, then, requires developing the skill of differentiating news from noise. Once acquired, this skill will aid in making investment decisions, and, perhaps more importantly, let you sleep more soundly at night with confidence that the portfolio decisions you’ve already made will continue to work for your benefit.
Reprinted from the November 2021 issue of the SmallCap Informer.
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