5 ways to lose money in the stock market

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Well, it has been a tough couple of weeks in the market, with some missed earnings from large corporations, inflation fears, and the flip-flop-flip of tariffs and trade wars. As we investors say, uncertainty is a market killer, and we have had a lot of uncertainty this month already.

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We at 5i Research don’t think long-term investors should lose hope, however. This is hardly the first trade war. We have seen lots of bad markets in the past 50 years. There is always something to fear or to worry about. But markets have still performed soundly over the long term, despite all the problems.

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We can’t tell you when the current market malaise is going to end. But at least there are ways to avoid extra problems. Investors as a group tend to do some common things, which almost always end up with them losing money. Let’s look at five common mistakes investors tend to make.

Buying fads

You know what we are talking about here. Nearly every investor has been caught buying a fad that didn’t work out. Cannabis? Check. Electric vehicles? Check. Dot-com companies (for the older folks)? Check. When there is a fad that is attracting investor attention and money it is important not to get caught up. Yes, there are often good companies doing well, and that’s how the fad or bubble is created in the first place. But investors can focus on smaller companies and there are always promoters and brokers willing to extol the virtues of a sector or specific businesses. Stick to the fundamentals. Don’t pay 100 times sales for a tiny company just because it is in a ‘hot’ sector!

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Buying leveraged ETFs

More akin to gambling than investing, leveraged exchange-traded funds (ETFs) and exchange-traded notes (ETNs) use derivatives to try and get two, three, or even four times exposure (up or down) to an underlying asset, such as a stock index. They can be useful for high-risk day traders, but their structure is horrible for investors holding longer than a day. The reset of derivatives results in a natural, ongoing, daily net asset value decay. The leverage works as all leverage does: It’s great when things go your way, and can be devastating when things do not. Let’s look at an example: FNGD is a Microsectors FANG+ Index 3X Inverse Leveraged ETN, tracking the inverse performance of a group of technology stocks. With tech being strong the past five years, its five-year annualized return is a blistering (sarcasm) negative 74.8 per cent, according to Bloomberg LP. Why do people buy these at all? Well, as usual, the answer is greed. At times, these products will soar in a very short period of time. That gets attention and investors want some of the action. But we think they are simply horrible products and it is best to avoid them.

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Buying companies that are constantly issuing shares

Some companies use their stock like an ATM machine, continually issuing shares to raise capital and diluting existing shareholders at the same time. Yes, we know that’s the main reason for the stock market. But, companies need to be self-sufficient at some point. A company that issues new shares year after year will find it hard to grow per-share earnings, even if the top line growth looks good. Sometimes companies will need to issue shares in order to acquire another company and we would consider that different. It is the companies that issue shares all the time and then either do nothing with the capital or, worse, use it to fund ongoing negative cash flow that we caution against. For example, we will pick on one company, the one we found in Canada with the most shares outstanding. You can connect the dots. IAnthus Capital Holdings Inc. has 6.7 billion shares outstanding and its 10-year stock performance is minus 99.3 per cent, according to Bloomberg.

Underestimating how much it costs to be public

Many investors seem enthralled by tiny micro-cap companies, those with market capitalization of $10M or less. We guess these investors are looking for “lottery tickets.” Yes, we know one way to get rich is to buy a million shares of a 10-cent stock and watch it go to $5. But seriously, how often does this happen? Answer: not very. Speculative investors seem to forget how expensive it is to be a public company. Suppose you are looking at an $8 million market cap company. Being public, with listing fees, regulatory fees, accounting fees, lawyer fees, shareholder costs and a PR firm might cost upwards of $400,000 annually. That is a five per cent expense drag on the entire company, every single year. If your broker tried to sell you a fund with a five per cent expense ratio, you would laugh at them. Of course, this discussion doesn’t even address the fact that small companies constantly need money and dilute shareholders with continued stock issuance. And guess what? If your stock is 10 cents, and you need $1 million in capital, you are going to have to sell a lot more shares to meet your capital budget than if your stock is $5. Our thoughts: Just forget about micro caps. Let others take these risks.

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Failing to pay attention to negative momentum

In frenzied markets like we’ve seen this year, investors often ask us, “This stock is down 55 per cent, it can’t drop any more, can it?” Well, yes, it can. A stock down 50 per cent can go down another 50 per cent, and could mathematically do this forever. Just because a stock is down does not mean it is a bargain. Sure, sometimes it is. But negative momentum can be a killer. In one of the uglier statistics we can throw out, there are more than 295 stocks down 20 per cent or more this year already. We found 29 stocks down more than 40 per cent year-to-date. Remember: Just because a stock is down does not mean it is going up.

Peter Hodson, CFA, is founder of 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)

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