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Rediff.com  » Getahead » 10 MORE tips to become a SMARTER investor
This article was first published 11 years ago

10 MORE tips to become a SMARTER investor

Last updated on: July 13, 2012 12:02 IST


Photographs: Rediff Archives Morningstar.in

In this article, we highlight 10 points that would help you score more on the bottom line.

In part one of this article, we covered 10 important tips that we think would make you a smarter investor. In this second and final part, we highlight 10 more points that would help you score more on the bottom line.

1. Don't be stubborn

David St Hubbins memorably said in the movie This is Spinal Tap, 'It's such a fine line between stupid and clever.' In investing, the line between being patient and being stubborn is even finer, unfortunately.

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 is this business' worth now? If I didn't already own it, would I 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.

2. Listen to your gut

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 double-checking your projections and calculations. Use valuation models as guides, not oracles.

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10 MORE tips to become a SMARTER investor


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3. Know your friends, and your enemies

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

4. Recognise the signs of a top

Whether it is tulip bulbs in 17th century Holland, gold in 1849, or Beanie Babies and Internet stocks in the 1990s, any time a crowd has unanimously agreed that a certain investment is a 'can't-lose' opportunity, you are probably best off to avoid that investment. The tide is likely to soon turn.

Also, when you see people making investments that they have no business making (think bellboys giving tips on bonds, auto mechanics day-trading stocks in their shops, or successful doctors giving up medicine to 'flip' real estate), that's also a sign to search for the exits.

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10 MORE tips to become a SMARTER investor


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5. 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.

6. 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.

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10 MORE tips to become a SMARTER investor


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7. Always have a margin of safety

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; margin of safety really is that important.

8. Think independently

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.

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 -- able to buy at the bottom, and sell at the top.

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10 MORE tips to become a SMARTER investor


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9. Expect surprises to repeat

The first big positive surprise from a company is unlikely to be the last. Ditto the first big negative surprise. Remember the 'cockroach theory.' Namely, the first cockroach you see is probably not the only one around; there are likely scores more that you can't see.

10. Prepare for the situation to proceed faster than you think

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.

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