Key Trading Pitfalls to Avoid

The stock market is an ever-evolving entity where exceptional companies are rewarded with high valuations, while mediocre firms attract low onesThis dynamic can create a captivating allure for novice investors, leading them to gravitate towards cheaper options, often resulting in regret when their investments fail to yield satisfactory returnsThis phenomenon begs the question: is price the most crucial determinant when selecting stocks, or is it the excellence of the company that should take precedence?

A comprehensive study funded by BG evaluated the returns of over 60,000 publicly traded companies worldwide from January 1990 to December 2008. Astonishingly, a mere 811 companies—representing just 1.3% of the entire pool—were responsible for generating all the wealth created in global stock markets during this periodThis stark statistic emphasizes a more extreme version of the Pareto principle, where one percent of companies brought forth 100% of market wealth, illustrating that excellence, rather than cost, is key to successful investing.

The celebrated investor Warren Buffett has distilled the principles of value investing into a straightforward mantra: “Buy excellent companies at reasonably effective prices.” Here, 'excellent' demands prominence over 'price.' While alternative strategies may succeed for some, the most accessible approach for the average investor is likely to remain investing in superior companies held over the long term.

With more than 5,000 companies listed on China's A-shares, stock selection becomes an upward battle resembling a complex tapestry of choices

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Many investors adopt various strategies, some of which prioritize fast-growing sectors, others that may place an emphasis on leadership in specific industries, or a preference for smaller enterprises focusing on valuation alone.

This myriad of investment tactics leads to various strategies and theories gaining prominence at different times, with some capturing the imagination of investors while others quickly fade awayDiscovering strategies that endure and thrive amidst cyclical ups and downs is akin to uncovering the mythical Holy Grail within investment circlesBut do such strategies exist?

In a certain context, the CSI 300 index can be viewed as a highly effective long-term investment strategy, characterized by its clear criteria for stock selectionIt targets the 300 companies with the highest average market capitalization, with adjustments made annuallyThis strategy aims for long-term holding, demonstrating impressive results; from the end of 2004 to January 20, 2025, it achieved an annualized return of 9.14% (including reinvested dividends)—a figure that surpasses the average GDP growth rate

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An initial investment of 100,000 yuan could have appreciated to 450,000 yuan today.

This remarkable performance of the CSI 300 index is not merely accidental; it stems from fundamental economic principlesAs a quintessential large-cap index, the CSI 300 represents industry leaders across various sectors, which reinforces the idea that larger companies tend to have a competitive edge due to their inherent advantages, such as exceptional management or substantial operational barriers that enable them to expand even furtherMoreover, most industries demonstrate significant economies of scale, where larger businesses typically enjoy enhanced profitability.

There is a well-known adage in financial circles: “The first leader eats meat, the second drinks soup, while the rest are merely along for the ride.” This succinctly captures the reality that in competitive markets, it is often the top players that reap substantial rewards.

In simpler terms, businesses generally incur both fixed and variable costs

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Higher revenue reduces the average impact of fixed costs on a per-unit basisConsequently, larger corporations tend to maintain a lower cost structure, allowing them to compete more effectively by cutting prices to gain market shareAdditionally, the network effect can exponentially enhance the competitive edge of platform-based companies, intensifying the 'Matthew effect' where the rich become richer.

This asymmetry between size and profitability is not confined to business but can also be observed in natureFor instance, biologists have determined that the metabolic rates of organisms tend to increase with body weight to the three-fourths’ power—a phenomenon where a larger animal, like A, which weighs twice as much as a smaller animal, like B, only necessitates 75% more energy and nutritionThis non-linear relationship suggests that larger animals are more efficient in their resource consumption.

This lower metabolic rate translates to reduced stress on cells, leading to lower rates of cellular damage and ultimately promoting longevity

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This principle holds true across species, where larger animals typically enjoy longer lifespans; for instance, mice may live between 1 to 3 years, whereas elephants can thrive for 80 yearsThe same logic applies within the corporate landscape, where larger enterprises often outlive smaller ones—consider that the average lifespan of a small business in China is about 3 years, while medium and large companies can last 8 to 10 years.

However, it's critical to avoid taking this argument to extremesJust as trees cannot grow indefinitely tall, both animals and enterprises face limits to growth—exceeding these may lead to decline due to factors like operational inefficiency or external economic pressure.

Currently, in the context of the A-share market, investors need not overly worry about the implications of reaching a critical mass, as China's economy continues to grow at a moderate rate with significant internal market potential and vast opportunities abroad

Focusing on companies within the CSI 300 index, for instance, reveals a median market capitalization of about 89 billion yuan and median revenue around 40.4 billion yuan, indicating that there remains substantial room for expansion in many sectors.

When evaluating individual companies, simply investing in recognizable leaders is insufficientInvestors must consider several important factors: First is assessing the growth potential of the industry in which the leading company operatesIndustries at different development stages will show vastly different growth potentials, so it is prudent to prioritize sectors currently experiencing stability or rapid expansionIndustries such as consumer goods, healthcare, and technology are in many ways favored for their intrinsic growth qualities.

Secondly, understanding the competitive nature of the industry is crucialDistinction exists between sectors marked by homogeneity—such as basic materials or many components of manufacturing—and those characterized by unique offerings where protective barriers promote limited competition, such as high-end alcoholic beverages or innovative pharmaceuticals