I’m guided by a simple principle: I do my best to tell you what I’d most want to know, if our roles were reversed.
With that in mind, let me share my list of the three most crucial things you should know…
No. 1. The most important thing for investors to understand about investing in stocks is simply what kind of businesses make for great investments and how to properly value these kinds of businesses.
You can think of this knowledge as your personal Google Earth for crossing “the desert” of investing. Knowing how to recognize great businesses and what they’re worth is like knowing where the sand dunes are and how to get past them.
Here’s an example of what I mean: Do you think coffee giant Starbucks (SBUX) is an expensive stock today? Why or why not?
If you can answer this question within 30 seconds by looking at a few key statistics, you’re ready to cross the desert. If you can’t… you’re not ready. You have to power up your satellite phone and spend more time studying your maps.
If you have no idea whether Starbucks is expensive or cheap, don’t worry. You’re not alone. Judging by my experiences with wealthy and business-savvy subscribers, I estimate that fewer than 10% of our readers really understand these concepts.
Without this knowledge, you can’t be successful as an investor. Not for long, at least.
No. 2. The second thing I know you must have to “cross the desert” successfully is a strategy that will continue to make you money even when you’re wrong about the big picture.
When we grow worried about a serious crash in stocks, we close some of our long positions. And we hedge our exposure to the market by selling short (betting against) some stocks.
But we don’t sell everything. And we don’t move to a 100% short portfolio. (In other words, we aren’t “all in” on betting that the market will fall.) As a result, we’ll do well even when the market defies our expectations.
The lesson is… you don’t ever want to bet the farm on any particular outlook (or any particular investment recommendation). That’s a hard idea for most investors to understand and implement…
When events in the world spook individual investors, they tend to pull out of stocks completely. They generally do so at the worst possible time. You have to learn how to make money even when you’re wrong about the market as a whole. And you have to follow your strategy… even when it’s scary.
No. 3. The last thing I think most individual investors either never learn or only learn the hard way after several big beatings is to never, ever chase what’s “hot.“
Investment “mirages” will cost you almost every time. It takes a lot of discipline to stick with great businesses that you can personally understand. It takes discipline to buy them when you can get them at a reasonable price. It takes discipline to follow your position-size limits.
When a great new business comes along – like online auctioneer eBay (EBAY) in the early 2000s – learn to be patient. Follow it for years, and buy it when it comes into your range.
If you had bought eBay back in December 2004, you’d have done great – and sure, eBay was and is a great business with a huge “moat.” Nevertheless, investors who chased after eBay while it was “hot” saw their investments decline as much as 80% by early 2009. It was far better to have bought it for less than $5 a share once it was trading for a reasonable price.
So again, I believe there are three things every investor in common stocks must know to succeed. If you can follow these ideas, you’ll be well on your way to crossing the desert…
- Know what kind of businesses make for great investments and how to properly value these kinds of businesses.
- Use strategies that will continue to make you money even when you’re wrong about the big picture.
- Never, ever chase what’s “hot.”
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Source: Daily Wealth