My highest priority is that I don't lose money. I invest for myself and a few friends, and I hate losing money, mine or theirs. In order to prevent that, I have set up a defense system.
1. I begin with a strict screen. There are hundreds of good companies out there. I am not looking just for a good company. I am looking for a great buy.
2. I buy companies with a high ROE. By high, I mean at least 25%. Generally a company cannot consistently achieve this without having an edge of some kind on their competition. Companies with an astronomical ROE are eliminated. I want to have a grasp on why they have a high ROE. I set the screener for an ROE between 25 and 100.
3. I look for very low debt. Companies that have slumps but no debt tend to bounce back fairly quickly. I once read that leverage is the only way that a smart man can go bankrupt. I never forgot that one! I set the screener for debt to capital under 10%
4. I avoid penny stocks, illiquid stocks, closed end funds, and ETF's. I want to buy a piece of a company that is producing something, and that I can sell as soon as I want to sell. I normally set the screener for a price over $5 per share and a volume range over 100,000 shares per day.
5. I base my buy and sell times on historical Price to Earning ratios.
- Price up, earnings up: If the earnings are growing then the price can go up without much change in the P/E ratio. I will hold on and ride the wave.
- Price up, earnings down or static: If the price goes up but the earnings don't change, I will sell when the P/E is at historical highs.
- Price down, earnings up: If the earnings are growing and the price is dropping, I will probably buy. I feel confident buying because I have already researched the company and know that it is solid.
- Price down, earnings down or static. I will probably sell quickly. Possibly an anomaly caused by an unusual situation, and so I may buy if it appears that the drop in earnings is only temporary.
I am watching WDC; IPXL; FSYS; HITK; AFAM; IDCC.
Disclosure: Long NE; LPHI; CFSG; XOM at time of writing.