Many new investors usually begin their investment journey by buying a stock that their friends or family introduced them to.
It can be a household name or a company that feels “safe”, but not necessarily a company that you know well.
But the single most costly mistake that Singapore investors make is exactly this: buying shares of a company without truly understanding its business.
On the surface, it seems harmless.
After all, big-chip names like DBS Group Holdings (SGX: D05) and Keppel Ltd (SGX: BN4) are well-known companies.
However, without fully understanding how the company makes money, what risks it faces, and the business fundamentals, investors are essentially buying blind, and that can be very risky.
Why does this happen?
Investors often think they know a company simply because they are familiar with the brand or its products, and consequently buy shares without fully understanding the business fundamentals.
Customer experience and sentiments can be very different from financial reality.
Rookie investors typically buy shares of major local banks such as DBS, United Overseas Bank Limited (SGX: U11), and Oversea-Chinese Banking Corporation Limited (SGX: O39) because they feel safe and are names they see everywhere.
However, they fail to understand how banks make profits and how earnings are heavily influenced by various factors such as interest rate cycles, Net Interest Margins (NIMs), and loan growth.
“Everyone is buying, and so should I” is also a common behaviour amongst investors.
Social confirmation makes it feel “safe” to invest, but following friends or trends in investing without doing ample research can be detrimental in the long run.
In both cases, expectations of the share performance can fall far from its actual results.
Why This Mistake Is Costly
Buying stocks of businesses that you do not understand can lead to emotional, inconsistent, and often irrational decisions.
Instead of confidence-driven investing based on knowledge of the companies, you end up reacting to noise.
This results in panic selling stocks of strong businesses during momentum downturns, or over-optimism of holdings that lack sustainable growth, or even misreading temporary issues as structural problems.
Investors who do not understand a business cannot properly differentiate between short-term headwinds, such as higher interest costs, and long-term structural problems like shrinking market share and outdated business models.
While it is a well-known name, Singapore Airlines Limited (SGX: C6L) functions in a cyclical environment where its profits are highly susceptible to fluctuations in travel demand.
A drop in travel demand or a pandemic like COVID-19 can greatly affect the company’s earnings.
Likewise, REITs with high yields can be attractive, but one must be careful and consider the debts they hold.
Instead, consider REITs like CapitaLand Integrated Commercial Trust (SGX: C38U), which offers around 4.6% dividend yield (at current share price of S$2.39) and holds a moderate gearing of 39.2%.
What Smart Investors Do Instead
The smartest investors cultivate simple habits to avoid buying shares of a company without truly understanding its business.
Before investing, spend time understanding the company, how it makes money, its growth potential, and what the limitations and risks it possesses.
Decide if you are a growth investor or an income investor, or if you would prefer a hybrid of both.
Defensive stocks like SBS Transit (SGX: S61) are relatively stable and provide a steady dividend payout.
For income seekers, SBS Transit offers an attractive 7.4% trailing dividend yield at S$3.20, excluding its 2024 special dividend.
Think long-term when you invest and study the company’s balance sheets to assess its cash flow, debts, and assets.
With a clear understanding of a company’s business fundamentals, you can make a more informed decision about your investment.
Get Smart: Understand The Business
Buying a stock without understanding the business behind it is that costly investment mistake that Singapore investors cannot afford to make.
Instead of following the trend or what your friends and family invest in, learn about the business so you can hold the right shares through volatility and not panic-sell at a loss.
Smart investing is less about predicting short-term price movements, but more about truly knowing what you own.
We’ve found 5 SGX-listed dividend stocks with strong track records in turbulent markets. If you want consistency in an uncertain world, start here.
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Disclosure: Wenting does not own any shares mentioned.
