How To Rationally Assess Your Investments
Warren Buffett is the king of investing. He was the original billionaire. Bill Gates has his Microsoft. Mark Zuckerberg has his Facebook. Jeff Bezos has his Amazon. Warren Buffett doesn’t know how to code, nor does he have any revolutionary ideas. He does, however, have his investments. While many of us are unlikely to scale up towards multi-billion dollar investment portfolio valuations, we can still learn something from his investing techniques. Here’s a short guide on how to rationally assess your investments, what to buy, and when to sell.
Rule №1: Never Lose Money.
While this seems obvious enough, if you’re a new investor, it’s easy to get caught up in the speculation process. You might have read something somewhere that encourages you to sell. The market might have done another dip.
Suddenly, you find yourself looking at a potentially big loss. The natural reaction is to sell and cut losses.
And that’s how you lose money. Investing is supposed to make you richer, not poorer. What many of us forget is that if you still have ownership over your stock investments, the stock value is only a paper valuation. It doesn’t become real and final until you decide to sell and cash out.
So if the investment you made a week ago suddenly dip into negative and you decide to sell, you will certainly make a loss. Your investment only makes a real profit when you sell during a time where the value is higher than what you originally paid.
Buy And Hold Sensibly
When it comes to choosing your investment, buy, and hold sensibly. What exactly does this mean?This means don’t just buy a company’s stock because everyone else is rushing to the market. Rather, take some time to step back, create a criterion and assess it accordingly.
Here’s some questions to help you get started.
- who are the competitors? does the company culture and processes foster innovation? what’s the company’s competitive edge? What are the company’s short and long-term strategies, and how feasible are they?
- how does the company make its profit? what are the sales channel, avenues, future sources of revenue?
- how sustainable is the business model? how old is the company and how resilient is it towards change? does the company have a history of adaptability?
Don’t buy a stock because everyone else is doing it. Buy stock because you are certain that it’s going to survive storms and grow.
Think Long Term
It can seem like a company can go up in value overnight. Sometimes, the big jumps and spikes entice us to join the upward trend.
The flip side of this scenario is when stocks suddenly plummet. It might be because of bad press or a product didn’t sell as originally hyped. Or in our most recent and still current experience — a pandemic.
When you buy an investment, there’s more to it than just flipping stocks. The long-term game involves dividend and distribution returns. The frequency depends on the company. Some distribute quarterly. Others may distribute only once a year or half-yearly.
The return rate can vary from year to year, based on profits within a particular period.
Sometimes, it’s better to hold stock long term and enjoy the profits via a steady dividend return rather than hoping that your investment will explode but have no income for the duration of the hold.
Don’t Just Know The Business, Understand It
It’s easy to buy into a business because you recognize the name. But do you understand it? Do you know their strengths and vulnerabilities?
For example, Amazon is predominantly associated with the sale and delivery of consumer goods. But did you know that their Amazon Web Services powers 31% of cloud hosting?
Beyond ads and the app store, do you know how else Google make their money? Sure, they have Google Cloud — but that’s only 6% of the total market share. AliExpress isn’t just a store. It’s part of the Alibaba Group, which makes up 37% of the total estimated cloud-based spending.
It’s easy to think that big names are safe bets, but you need to understand the business and its product offerings before you jump in.
Ignore The Trends
Once you buy a stock or two, stop looking at the daily market movements. If you’ve done your research and trust that the company will make the right decisions, then you’ve got nothing to worry about.
Speculators move the prices up and down. Sometimes people just want to cash out. Sometimes a company gets hit with good and bad publicity.
Look at Tesla. Speculators move the price up and down based on Elon Musk’s tweets. It always bounces back eventually when the product positively affects the bottom line.
Identify Competitive Moats
Victoria’s Secrets fell apart because they didn’t maintain their competitive moat. The brand couldn’t protect their advantages against cheaper alternatives, nor did it adapt in time to the changing market.
A competitive moat is that the company can provide a good or service that outperforms its competitors.
Apple maintained it for a long time through design integration. Now it’s arguable that they’re struggling because of how quickly their competitors are catching up, if not doing better.
There are 4 different types of moats. Here’s the list and how to identify them for the business you’re interested in:
1. Cost Advantage
Competitors can’t replicate easily, or at an economically cheaper rate. This prevents competition through like-alternatives. Companies with sustainable cost advantage often end up with large market shares and often squeeze out smaller and newer competitors through pricing.
2. Size Advantage
The size of a company can be an actual competitive moat. It can leverage economies of scale (cost advantages through production size), fund experiments and innovation, and have reduced overheads because they have the funds to optimize it.
3. Switching Cost Advantage
The switch cost advantage is the price that customers have to pay to go to a competitor. It might be through time or a specific monetary value. Apple users, for example, has a high switching cost. Android users, however, can move between the different brands available. When there is a high switching cost, competitors can struggle to take market share away.
There’s more to just selling and keeping customers locked in. Intangibles are assets such as brand name recognition and association, patents, and licenses.
Rational Judgment Over Emotions
Rational judgment involves assessing future outcomes based on facts. This means looking at financial reports, sales figures, and expected future products.
It also includes looking at historical trends and how types of events affected the value and profitability.
Ignore the emotions. Be rational. Look at models, or create your own scenarios and expected outcomes. Accurate “gut feelings” come from training yourself to recognize patterns, scenarios, and their potential results.
Ignore Buy Low, Sell High
If you’re after a get rich quick scheme through investing — that’s called gambling.
Markets fluctuate. If you’re only buying to hold short term and get rid of it when the market goes on a brief high, be prepared to be disappointed.
Real investing is an economic science that involves more than just speculating what the public thinks about a particular company at a certain point in time.
Look At The Bottom Line
Always look at the bottom line. Has the company made a profit? Is it likely to make a profit? What’s the trend on profit?
Successful businesses make more money than they spend. Dividends are distributions based on profit levels. Stocks often go up or down significantly based on reported profits.
What’s The Debt Ratio?
Venture capital is the latest craze. Some companies are valued at billions — but how much of it is propped up by investors and financing?
Warren Buffett prefers companies with debt to equity ratio that’s below 0.5. He’s not against the idea of debt — but just not too much that it has the ability to damper on potential operational processes. Having a lower debt to equity ratio also gives the company space to move when they look to borrow.
Debt to equity is calculated as follows:
debt / equity = debt to equity ratio
So for every $1 of equity that a company has, it should have $0.50 or less in debt. This means that when debt is due, the company will not go into a systematic shock and can pay it off if needed.
If a company is surviving through debt, however, then it might mean that they’re struggling to make a sizable profit against the debt-financed investment.
Investing is easy. Nowadays there are apps and services that provide easier access to stock trading.
Investing is not a gamble when you make informed decisions.
If you want to grow rich through investments, you need to look beyond what everyone else is doing and dig into the books. There might be things that surprise you and help you make the right decision.