What Every Investor Ought To Know About Stocks

As a new investor, you’re probably overwhelmed by how much information is available on financial markets. This short guide will give you some ideas on how to play the game.

Should You Only Rely On Safe Stocks?

How do you find healthy companies? Do you just pick well-known companies like Apple and Google? Do you then simply hold on, hoping things will work out in the long run?

Frankly, the best investments aren’t the things we know. It’s usually the things we discover.

What Is The Best Rule?

There is no single rule. There is no strategy that is most important.

Still, top investors have come up with investing rules of thumb. When you follow them, you will do better than most people who jump into the market.

Suppose you read a recommendation about a finance company for car buyers. You’re excited because you know people love to buy cars and getting stock in a finance company in this industry may be your ticket to wealth.

You go to see what CNN Money has to say about Consumer Portfolio Services. The first thing you would notice is that the company had a bad start this year. It was down 23.91% for the year.

Now you head over to Yahoo finance to see what they have to say about Consumer Portfolio Services. Here the stats are presented in a different way. You notice that the company has a market cap of 142.08 million.

So, is this or is this not a good stock?

Here are three rules to help you make a decision:

Rule # 1. Focus on what you can know.

This rule comes from one of the best hedge fund managers in the world, Seth Klarman. He mentions it in his classic book, “Margins of Safety.”

It’s not enough to get a good idea then begin looking for stocks that will work with that idea.

It’s a good idea, for example, to take advantage of rising interest rates. Do you then look for companies that will benefit from rising interest rates and buy their stocks? Unfortunately, it’s not that easy. There is a lot more information you need to know. Where will the rates go? When will they go up? The many things that you cannot know about rising interest rates will hurt your investment.

What can you know? You can know that WalMart has mastered efficiency of scale and can sell lower than its competitors. You can know that Costco turns over its inventory faster per square foot than any other bulk retailer. You can know that RadioShac sells its stuff higher than its competitors and that this is not to its advantage.

Rule #2. Know more to earn more.

Although Warren Buffett did not invent the rule, he shows better than any investor alive today how to use it.

Did you know that on an average day, Warren Buffett can spend as much as eight hours reading, slipping his study between strategic meetings and other business that demands his attention? When he was still in high school, he read every book in his city library on finances—twice!

However, his business partner Charlie Munger may give him a run for his money. Munger is famous for his quip, “The game of life is the game of everlasting learning. At least it is if you want to win.”

The people who make the most money in the stock market—or in any market for that matter—know more than everyone else.

First of all, you need to know the basics. What are the key concepts? How exactly does the stock market work? It’s not enough to simply know that a stock is buying a small slice of ownership in a real business. Relying on stock price alone and past projections is not significant knowledge, either. You need deep wisdom if you want to have deep pockets.

In addition to learning from books, attending seminars, and consulting with experts, learn from your mistakes and learn from top investors.

Rule #3: Observe a margin of safety.

This rule was developed by Warren Buffett’s mentor, Ben Graham. He mentions it in his book, “The Intelligent Investor.”

When you buy an investment, you should do it at less than its intrinsic value. Why? This is because you will have a margin of safety by weighing its value conservatively.

If your evaluations are completely wrong than you have less to lose. If your evaluations are right, you will profit handsomely. It’s impossible to have an accurate assessment of the future, and a margin of safety makes it unnecessary to be 100% accurate.

Buffett has expanded Graham’s definition by considering the quality of a business. It’s not enough to find an undervalued business where the stock can be purchased at a bargain. Can the business reinvest in its own growth over a long period of time?

To Buy or Not to Buy?

When you apply these three rules to the data on any company whose stock you’re thinking of buying, everything will begin to make a lot more sense and you’ll be able to come up with some clear decisions.