Mistakes to avoid when looking at benchmarks

Reference indicesAs you have already read me very much (there are already almost 500 articles that I have published on this blog for the last 4 years), today I bring you an article written by a guest author. This is Marc Alomar Lluch, from the blog índices bursátiles. I hope you like it. 😉

Hello!

Before starting, I want to thank Paco for the opportunity to collaborate on his fantastic blog, undoubtedly a reference for those of us who practice the philosophy of Value investing.

As a good value investor, you know that you must carry out a detailed and rigorous analysis, company by company, with the aim of discovering the businesses that seem to you of the highest quality. Once you identify the companies that you would like to include in your portfolio, you know that to turn an excellent business into a fantastic investment you must buy their shares at a price lower than their intrinsic value, thus enjoying a good margin of safety.

It may be that to know if the Stock Market is rising or falling, the first thing you look at is the benchmark index of the market that interests you. If this index rises strongly, you regret believing that your opportunity has passed; if it collapses, you get excited thinking about how cheap you can buy your favorite stocks.

With this in mind, today I want to talk about three typical mistakes that you run the risk of committing if you give excessive importance to stock indices when making your investment decisions. With them I want to show you that it does not always mean that the benchmark rises that your opportunity has passed, and that it does not always mean that it collapses that you will be able to buy the shares you like at the right price.

Tabla de contenido

  • capitalization bursátil of the companies that form it.

    Therefore, one of the most common mistakes is to think that an index represents all the companies that are listed on that Stock Exchange, when in reality it only takes into account the companies with the largest capitalization. For example, the Continuous Market, which groups the four Spanish Stock Exchanges, is made up of more than 150 companies, while the Ibex35, its reference index, takes into account only the 35 with the largest capitalization.

    Therefore, it may be that the excellent deals that you have identified are not part of the benchmark for your market, so it is telling you absolutely nothing about whether the price of your preferred shares is going up or down.

    Mistake # 2: Thinking that the behavior of the index reflects that of all the companies that comprise it

    In some cases, the companies from which you want to buy shares will be part of their market benchmark. It is on these occasions that you are more susceptible to making the second mistake I want to talk about: thinking that all the companies in the index behave the same as this one.

    Remember that an index is nothing more than a weighted average based on the capitalization of its components. Therefore, you should always keep in mind that the fact that the index is rising, even if it is rising strongly, does not necessarily imply that your particular preferred stocks are also rising in price. They may, but they also may not.

    A typical mistake is to think that if an index is cheap, all its components are cheap. This can lead you to buy your shares at too high a price, lowering your margin of safety, increasing the risk of your investment and reducing its profitability.

    The example of the Ibex35

    When a few components have a very significant weight within an index, it is said that it is concentrated. So that you can see to what extent a few businesses can mark the evolution of an index regardless of what the rest of its components do, below I show you the weight of the five companies with the highest capitalization within the Ibex35:

    intrinsic value reasonable and buy them only when the price is cheap enough to get a good safety margin.

    Remember, making your investment decisions by looking only at indices can lead you to overpay your shares and miss out on good opportunities thinking that you are no longer on time. To avoid these mistakes, focus on the individual value of your shares and try to buy them at the lowest possible price.