Stock

A stock (or ‘share’, or ‘equity’) is a type of security that signifies ownership in a company and represents a claim on part of that company’s assets and earnings.

There are two main types of stock.  These are common stock and preferred stock.

Common Stock

This usually entitles the owner to vote at shareholders’ meetings and to receive dividends.

Preferred Stock

This generally does not come with voting rights, but it will have a higher claim on assets and earnings than the common stocks.

A holder of stock is called a shareholder and has a claim to a part of the corporation’s assets and earnings.  In other words, a shareholder is an owner of a company.  Ownership is determined by the number of shares that a person owns relative to the number of outstanding shares available.

Stocks are generally the foundation of any investment portfolio.  Traditionally they have outperformed most other investments over the long term.

Tips for Investing in Stock

Do Not Over-Complicate

Keeping it simple in investing is not stupid.  Those who trade too often, focus on irrelevant data points, or try to predict the unpredictable are likely to encounter some unpleasant surprises when investing.  By keeping it simple and focusing on companies with economic moats, requiring a margin of safety when buying, and investing with a long-term horizon, you can greatly enhance your odds of success.

Set Suitable Expectations

Are you getting into stocks with the expectation of getting rich quick?  Unless you are extremely lucky, you will not double your money in the next year investing in stocks.  Such returns generally cannot be achieved unless you take on a great deal of risk by, for instance, buying extensively on margin or taking a flier on a chancy security.  At this point, you have crossed the line from investing into speculating.

Although stocks have historically been the highest-return asset class, this still means returns in the 10 to 12 per cent range.  These returns have also come with a great deal of volatility. If you don’t have the proper expectations for the returns and volatility you will experience when investing in stocks, then you will struggle to make your investing work.

Be Prepared to spend Time in the Market

In the short term, stocks tend to be volatile. Trying to predict the market’s short-term movements is impossible.  Yet all too many investors are still focused on the popularity contests that happen every day, and then grow frustrated as the stocks of their companies, which may have sound and growing businesses, do not move.  Be patient, and keep your focus on a company’s fundamental performance.  In time, the market will recognize and properly value the cash flows that your businesses produce.

Do not react to every report

There are many media outlets competing for investors’ attention, and most of them centre on presenting and justifying daily price movements of various markets.  This means lots of prices accompanied by lots of guesses about why prices changed.  Unfortunately, the price changes rarely represent any real change in value.  They merely represent volatility, which is inherent to any open market.  Taking little notice of this will not only give you more time, it will help you focus on what’s important to your investing success, which is the performance of the companies you own.

Behave Like an Owner

Stocks are not merely things to be traded, they represent ownership interests in companies.  If you are buying businesses, it makes sense to act like a business owner.  This means reading and analysing financial statements on a regular basis, weighing the competitive strengths of businesses, making predictions about future trends, as well as having conviction and not acting impulsively.

Buy Low, Sell High

If you let stock prices alone guide your buy and sell decisions, you are letting the tail wag the dog.  It’s frightening how many people will buy stocks just because they’ve recently risen, and those same people will sell when stocks have recently performed poorly.

When stocks have fallen, they are low, and that is generally the time to buy.

When they have shot up, they are high, and that is generally the time to sell.

Don’t let fear or greed take over your decision making.

Watch Where You Anchor

Unfortunately, many people anchor on the price they paid for a stock, and gauge their own performance (and that of their companies) relative to this number.

Remember, stocks are priced and eventually weighed on the estimated value of future cash flows businesses will produce.  Focus on this. If you focus on what you paid for a stock, you are focused on an irrelevant data point from the past. Be careful where you place your anchors.

Remember that Economics Usually Beats Management Competence

Keep in mind that management can (for better or for worse) change quickly, while the economics of a business are usually much more static.  Given the choice between a wide-moat, cash-cow business with mediocre management and a no-moat, terrible-return businesses with bright management, take the former.

Be Aware of Management Practices

Though the economics of a business is key, the stewards of a company’s capital are still important.  Even wide-moat businesses can be poor investments if questionable management are in place. If you find a company that has management practices or compensation that makes you cringe, then follow your gut.

Bear in Mind that Past Trends Often Continue

Past performance is a good indicator of how people will perform again in the future.  This applies not just to investment managers, but company managers as well.  Great managers often find new business opportunities in unexpected places.  If a company has a strong record of entering and profitably expanding new lines of business, make sure to consider this when valuing the firm.  Don’t be afraid to stick with winning managers.

Prepare for things to move quickly

Most deteriorating businesses will do so faster than you anticipate.  Be very wary of value traps, or companies that look cheap but are generating little or no economic value.  On the other hand, strong businesses with solid competitive advantages will often exceed your expectations.  Have a very wide margin of safety with a troubled business, but do not be afraid to have a much smaller margin of safety for a wonderful business with a shareholder-friendly management team.

Expect Surprises to Repeat

The first big positive surprise from a company is unlikely to be the last. Same with the first negative.

Don’t Be Stubborn

In investing, the line between being patient and being stubborn is even finer.  Patience comes from watching companies rather than stock prices, and letting your investment theses play out.  If a stock you recently bought has fallen, but nothing has changed with the company, patience will likely pay off.  However, if you find yourself constantly discounting bad news or downplaying the importance of deteriorating financials, you might be crossing that fine line into stubborn territory.  Being stubborn in investing can be expensive.

Always ask yourself what the business is worth now.  If you didn’t already own it, would you buy it today?  Honestly and correctly answering these questions will not only help you be patient when patience is needed, but it will also greatly help you with your selling decisions.

Gut Instinct

Any valuation model you may create for a company is only as good as the assumptions about the future that are put into it.  If the output of a model does not make sense, then it’s worthwhile to double-check your projections and calculations.  Use DCF valuation models as guides, but not bibles.

Know Your Investment

What’s the short interest in a stock you are interested in?  What mutual funds own the company, and what is the record of those fund managers?  Does company management have a meaningful ownership stake?  Have company insiders been selling or buying?  At the margin, these are valuable pieces of collateral evidence for your investment research on a company.

Recognise a bubble

Any time a crowd has unanimously agreed that a certain investment can’t lose, you are probably best off to avoid that investment.  The tide is likely to soon turn.

Look for Quality

If you focus your attention on companies that have wide economic moats, you will find firms that are virtually certain to have higher earnings five or 10 years from now.  You want to make sure that you focus your attention on companies that increase the intrinsic value of their shares over time.  These afford you the luxury of being patient and holding for a long time.  Otherwise, you are just playing a game of chicken with the stock market.

Don’t Buy Without Value

The difference between a great company and a great investment is the price you pay.  There were many fantastic businesses around in 2000, but very few of them were attractively priced at the time.  Finding great companies is only half the equation in picking stocks.  Figuring out an appropriate price to pay is just as important to your investment success.

Have a Safety Margin

Unless you unlock the secret to time-travel, you will never escape the inherent unpredictability of the future.  This is why it is key to always have a margin of safety built in to any stock purchase you may make.  You will be partially protected if your projections about the future don’t exactly pan out the way you expected.

Having a margin of safety is a recurring theme among several great investors.  This is no accident.  Maintaining a margin of safety really is that important.

Do not rely on the advice of others

Great investors are willing to go against the grain.  You should find zero comfort in relying on the advice of others and putting your money where everyone else is investing.  Quite simply, it pays to go against the crowd, because the crowd is often wrong or too late.

Also remember that successful investing is more about having the proper temperament than it is about having exceptional intelligence.  If you can keep your head while everyone else is losing theirs, you will be well ahead of the game.

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