This list is made up of the five things that I believe are fundamental attributes of any successful investor. An investor must approach any investment with logic, detachment and a long-term view -- unless you're a day trader. Of course the normal caveats apply, as these rules will not make you "get rich quick," or become connoisseur of markets overnight, but they will help you avoid some of the most common and money-costly mistakes. If you follow these rules, you should be able to recognize an opportunity when you see it and avoid losing money from silly blunders. Better investing doesn't happen accidentally-- good investors work at it. They study. They learn. However, everybody starts somewhere, and if you start with these five rules, you'll be off to a good start.
1. Understand the Company
Too often I see people invest in companies that they don't have a clue about! I have met people that literally could not tell me what services or good the company delivered. It is essential to at least understand the basic logistics of the company, as well as any potential market influences. For example, Coca Cola (KO) is very reliant upon the prices of plastic. If plastic prices increase, Coca Cola margins could decrease and potentially drive the stock price down. You don't have to be a programmer to invest in Apple (AAPL), but you should have a good idea of the ever-evolving competitive landscape for the company's products -- the iPad, the iPhone and iMac.
You should also have a decent understanding of the company's management. Do you believe that CEO Tim Cook can fill Steve Jobs' shoes? Tell me, would Apple's stock price be as low as it is of Steve Jobs was still the leader? Some companies -- Berkshire Hathaway (BRK.B) is a good example -- seem hitched to a specific leader. For others, the culture is spread throughout the company. These are the types of influences you should always be aware of when investing in any type of security. It is the most imperative fundamental any investor must possess.
2. Price Matters
Price is so important, that if it is low enough, investors are willing to buy stocks of companies they don't even like that much; even when the fundamentals of the underlying company are deteriorating. Typically, there's a lot of space between a "best of breed" company and one that's probably not worth investing in.
In normal circumstances, then, if a company's stock falls to a certain level that makes it just too darned cheap to pass up, it's perfectly okay to buy when you merely have a low opinion of the underlying company. That's when price matters.
Example: Apple's Fall
The stock was trading around $700 of September 2012, only to take a precipitous decline to its current price of around $440. Did the company rack up enormous amounts of debt and completely kill its balance sheet? No! Sure, revenues have been on a downtrend, but Apple is still one of the most fundamentally solid companies on the market today. Its margins are incredible, and at one point, Apple had more cash than the U.S. treasury!
So how do you know when the price is right for a stock you wouldn't otherwise buy? It's a sliding scale - where the better the company, the more you should be willing to pay. Companies that are trading at a discount, but still fundamentally solid (like Apple) are always good options.
If speculating, look for companies that have been left for dead, even though they still have a pulse upon closer inspection. Just be sure that bankruptcy is not on the table. So long as bankruptcy is not on the radar, then buying an unattractive company at an attractive price could make a lot of sense.
3. Be News Agnostic
Avoid being swayed by the news of the day, whether it's good or bad. Focus on trends versus headlines. Expose yourself to thoughtful interpretation of what's going on by following analysts, journalists and bloggers you trust. Consumers and investors pay too much attention to the new, rather than focusing on the underlying derivatives of the stock - its fundamentals.
Fluctuations in stock price are completely inevitable, but a company that has a solid foundation will always grow in the long term. Most of the time, economic news is fairly benign. I don't wish to imply it is meaningless, but it is not a driver of stock markets. Indeed, the correlation between economic noise and how equity markets perform has been wildly overemphasized.
Example: Top Stock Picks
If you were to look at Thomson Reuters 10 stocks that Wall Street analysts liked in 2011- the stocks that analysts rated most highly stocks in the Standard & Poor's 500 index with the most "buy" and "strong buy" recommendations, the fewest "sells" (let alone "strong sells") and the best average rating overall, you would notice that the picks did very well. If you'd invested $1,000 in each one, your $10,000 stake would have grown to nearly $12,400-an impressive 24% return.
And what about if you had gone completely against the grain, and had invested in the stocks that the analysts hated the most? You'd have made an incredible 70% profit. Sears Holdings, (SHLD) the most-hated stock of all, more than doubled. Ford Motor, (F) which was the fourth most hated, quadrupled.
This just goes to show you that you cannot always believe what you read or hear on the news. To quote Warren Buffett: "If you knew what was going to happen in the economy, you still wouldn't necessarily know what was going to happen in the stock market."
4. Don't Believe The Hype
Not all upside surprises are worth getting excited about. If a company reports quarterly results that show its earnings-per-share are higher than what the average analyst on Wall Street had expected, then all of the headlines will describe it as an upside surprise. Stocks are supposed to go up when the underlying companies they're attached to deliver higher earnings than anyone had expected, but what the headlines call an upside surprise and what truly impresses the professionals in a quarter are two different things.
Example: Post Earnings Announcement Drift Phenomenon (PEAD)
Post Earnings Announcement Drift, or PEAD, is an anomaly where stocks with positive earnings surprises continue to exhibit excess gains for weeks following the earnings announcement, but eventually come back down to its valuation level. In 2012, analysts expected Corinthian Colleges (COCO) to report 1 cent per share, but in the February earnings report, COCO delivered 4 cents per share (excluding impairment charges on a diluted basis). Within 24 hours, prices shot from $3 to $4 per share, but eventually came down to its current level of $2.00.
Headline writers don't draw a distinction between a high quality upside surprise and a "low quality, illusory" upside surprise. Investors can tell the difference, though. A high-quality upside surprise is generated by higher-than-expected sales, which leads to better-than-expected earnings per share. Improved sales means the industry is improving and more people are buying the company's products, or it could mean that the company is taking market share. Either way, it bodes well for the company.
On the other hand, a low-quality upside surprise is based purely on a better bottom line (earnings per share) than the top line (the sales number). In this case, the upside surprise is not generated by improved business, but because management cut costs, changed their accounting practices or bought back shares. None of these things matter to Wall Street analysts, though. Instead, they want to see a company's ability to deliver better-than-expected sales.
5. Think For Yourself
Along my investment education, I've been amazed to find that there are only a couple of folks out there who think for themselves. These names include Jim Rogers, Bill Gross and Warren Buffett. But it is an amazingly short list. Remember, the employees of a brokerage firm are not paid to think for themselves. So you'll be able to beat the brokerage firms in no time. If you're simply copying their advice, you'll never beat them. This fundamental is synonymous with not paying attention to headlines. YOU are the one ultimately making the decisions with YOUR money. Do not let somebody else tell you where to put it!
There are plenty of valuable resources out there to further your investing knowledge. Start by going to your local bookstore and picking out some books that tailor what you are trying to achieve. The investment process is always a work in progress, but taking the time to reflect upon and improve it is a sure step to becoming a better investor. If you start off with the five aforementioned tips, you'll be on to a good start.