“Risk comes from not knowing what you are doing.”
– Warren Buffett
It’s really exciting… the first time you see the money in the investment account. Waiting for action.
I remember vividly how it felt like, purchasing my very first stake in Wells Fargo & Co. You just can’t wait to get started, hoping for it to turn out well in the long-term. Kinda like a first date.
While I have only started on this value investing journey for a short 3 years and have much more to learn, here are a few points that I have learnt.
** From the POV of a rookie value investor. Sorry I know nuts about technical analysis to be able to weigh in on that.
1) Knowledge is Key
I believe in acquiring sound knowledge on analysis of financial statements FIRST, to understand the mechanics and to mitigate some risks.
- Read accredited investment books
- The Internet (E.g. http://www.investopedia.com/ gives a basic knowledge on investment concepts, financial ratios)
- Sign up for an investment course
For me, I learnt the most through a paid investment course focusing on value investing and options strategies. There are experienced investors to guide you and a network of like-minded individuals to meet.
Read about different types of investing here to see what might be your cup of tea: value investing, income investing etc. (http://www.investopedia.com/university/stockpicking/)
Whatever the choice, say hello to financial ratios and acronyms. 🙂 ROE, ROA, P/E, D/E, DCF method, Market Cap etc.
2) View a Company as a Business, not Just a Stock
I used to look at the prices of the stock first when assessing if a company was a decent buy. But after learning about value investing, I was taught to look at the business first and foremost.
One of the many measures to assess a business is its ability to earn. (Earnings Per Share – EPS)
Lets say the owner of an established firm asks you to invest in his company. You might ask is whether his company is making money. If the earnings are dismal, it ain’t a good business.
Same for listed companies that aren’t earning well. Whatever price they are trading in the market, value investors won’t consider as they look for undervalued and ALSO good securities.
Of course there are other factors to assess a company’s performance like the debt ratios, return on equity, cash flows etc.
All in all, do look beyond the price movements to understand the value and performance of a company.
3) Start off with Blue-Chips
I started off with a blue-chip company (WFC) listed on NYSE. A blue chip typically has a large market capitalization. (http://www.investopedia.com/terms/m/marketcapitalization.asp)
For the first company that I bought into, knowing that it’s a industry leader made me feel safer too. Think Coca-Cola, Johnson & Johnson, Procter & Gamble etc. Some reasons why they are favoured:
E.g. companies like Coca-Cola boasts steady earnings as a result of many factors:
- Diversified beverage portfolio beyond just carbonated drinks.
- Extensive distribution networks across markets.
- Strong and steady consumer demand with wide consumer base etc.
Companies with these kind of business profiles will constantly earn money.
* Some blue chips might be too costly to buy directly. Consider these perhaps?:
4) Buy When the Company is on ‘Discount’
I learnt that even if the company is a good business, it still has to be at a reasonable price before I should buy.(http://www.investopedia.com/terms/i/intrinsicvalue.asp)
Lets say you wanna buy a new mobile phone. Though iPhone is a great product, but no way you would probably spend $2,000 to get the latest model. A good product but bad, over-pricing.
Value investors will only buy when the current market value is below the intrinsic price.
You could use a variety of methods to estimate it:
- Discounted Cash Flow Method (http://www.investopedia.com/terms/d/dcf.asp)
- Secondary sources like S&P analysis reports, Trefis (http://www.trefis.com)
- P/E ratio (can’t show the estimated intrinsic value, but a company’s P/E trend can indicate if it’s currently undervalued)
5) Don’t Speculate
Recently an acquaintance bought into some penny stock at the recommendation of his broker. The selling point was that the stock had huge upside potential and the price would rise in the very short-term.
Unfortunately my friend was on the losing end that time. Besides, the rationale to justify the purchase wasn’t rock solid too.
Well that is speculation or even gambling. Sometimes you win, sometimes you lose.
6) Don’t Sweat the Small Ups & Downs
In 2012, I bought a few hundred stocks of JP Morgan just a few weeks just before the widely publicized trading scandal. Tough luck isn’t it? (http://en.wikipedia.org/wiki/2012_JPMorgan_Chase_trading_loss)
The stock price plummeted by as much as 30% in a short span of time. But… I didn’t sell the stocks as it would have translated to actualized losses – against a value investing principle.
So I constantly reminded myself that the company has strong fundamentals after all, which was why I bought it in the first place.
Crossed my fingers. Honestly, I was still kinda bothered by the sharp drop.
Stock Price of JP Morgan took a nosedive in Q2 2012 when the news on trading losses broke out.
The company carried on with its business as usual. Their financials looked pretty decent in 2012 nonetheless, including recording good earnings as seen below. See other ratios here: (http://www.gurufocus.com/financials/JPM)
Earnings per Share still grew in the year of the hugely publicized losses
For me, it was the first time that I truly saw the principles of value investing in action.
So.. I learnt not to sweat it. Especially for people like myself with a full-time job, I can’t afford to worry and lose sleep over movements in my stock portfolio.
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