By Adam Bark
Investing in stocks is complicated, isn’t it? Well, it can be complicated if you don’t know what you are doing. However, once you do, it becomes rather simple. Find what stocks are undervalued, buy them and watch them grow. I am not making this up, it is that easy. And if you master it, you will get rich. Here are ten rules to follow so you can do just that.
1. Be patient. As value investors we invest for the long run, we should buy stocks and be prepared to hold on to them for decades if there’s no reason for us to sell them. Long term means long term, don’t expect to become as rich as Warren Buffett in a week, building wealth takes time. Get greedy in search of quick money and you will usually lose it all. Be on your guard for ‘get rich quick schemes’, as the only person getting rich will be the con artist selling them. The financial history books are full of Wall Street charlatans, just make sure you don’t fall for the next. If the deal looks too good to be true, it probably is.
2. Only Invest in healthy companies. Learn how to read balance sheets, income, and cash flow statements, these are the documents which will tell you state of the company’s financial situation. Stay the hell away from companies with financial cancer, even if the price is low, don’t invest in them. What you ideally want to see is low debt, increasing profits, high investments and a mountain of cash. What you don’t want to see, is well, the opposite.
To get an even deeper insight into a company’s financial strength use other key metrics such as the ROE, the ROIC, current and quick ratios, the company’s free cash flow, and its operating profit.
3. Find the intrinsic value of a stock. This way you will know the stock’s fundamental value. There are various methods to calculate it and the final result will vary, as different approaches prioritize different metrics. Calculating the value is more of an art than a science, and a lot is based on personal predictions of the company’s future growth. Personally, I prefer to use Warren Buffett’s DCF method.
4. Have a margin of safety. Only invest, if the price is at least 20% (or any number you are comfortable with) less than its intrinsic value. This way you leave space for error in your valuation. Think about it, if a bridge holds can hold vehicles up to 8 tones, would you really be comfortable driving an 8 ton truck on it?
5. Don’t listen to Mr. Market. Every day he will knock on your door with new deals, don’t fall for it. People are often irrational, they will sell when scared and buy when excited. That means stock prices are often either overvalued or undervalued. Don’t let emotions cloud your judgment. Buy only buy if you’re getting a good deal. Remember, that in the short run the stock market is a popularity contest in which the most popular companies grow in value. However, in the long run the stock market is a weighing machine in which companies with real value and strong fundamentals outperform those without them.
6. Invest in what you know. Understand the business and keep up with new developments. Don’t buy a tech stock if you can’t even send an email.
7. Diversify only if you don’t have the time and energy to learn about investing. If you know what you are doing, then you can have better returns by picking stocks yourself or hiring a financial advisor. However, if you do decide to invest with a financial advisor be careful when choosing one, make sure he is honest, reliable and has a good reputation. He should be dedicated to making you money, not in making it for himself via the commission fees of constantly buying and selling stocks. Ideally you should know enough about investing to understand what he is doing with your money. You would be surprised to know just how many financial advisors and brokers are unfortunately just in it for themselves. So, stay vigilant. If you want to take the route of individual stock picking, make sure it is worth your time. You should aim to outperform the S&P 500 index fund: a basket containing the stocks of 500 of the largest US publicly traded companies. It averages a 10% return, so you should strive for at least 11-12%. Keep in mind that the more risk you are willing to take, the higher potential return you could gain.
8. Watch out for inflation. It will chip away at your income. Currently, inflation eats up almost 2% of your yearly returns, which means that your money is worth 2% less every year. Expect it to get substantially worse in the future, due to the government’s fiscal and monetary policy in response to Covid-19.
9. Understand compound interest. It could make you filthy rich in the long run. Most people do not grasp the concept, so let me give you an example. Let’s say you invest $1000 a month in the stock market, with a fairly conservative average yearly return of 12%. In 40 years’ time your investment will be worth $9,298,148 and that’s not even counting the possibility of dividend reinvestment. If the yearly return was 15%, which is a realistic goal for experienced investors, after 40 years your investment would be worth $21,616,947. Mind blowing, isn’t it?
10. Don’t lose money. The golden rule of the greatest investor who has ever lived, the Oracle of Omaha, Warren Buffett. Don’t lose money, simply because it is a lot easier to lose the money you have made, than to make back the money you have lost. This should go without saying, but avoid losing money at all costs, it’s not pleasant, trust me.
Follow these rules and the sky is the limit. The possibilities are endless, you could one day end up being the next Warren Buffett. Who knows? Well, in all honesty, probably not, there’s only one Buffett. However, by following these rules you can still build a huge amount of wealth. So, get out there and use them!
Disclaimer: The Content is an opinion and is for information purposes only. It is not intended to be investment or financial advice nor does it constitute an offer to buy or sell or a solicitation of an offer to buy or sell shares or any other assets. Seek a duly licensed professional for investment or financial advice.