The secret to investing success is there is no secret. There are no magic words or millionaire insider tricks. The secret to investing success is identifying great companies and buying them at a price that provides an opportunity for growth. In summary, the secret to investing success is two parts:
- Identify a great company
- Buy at a great price
- There are no shortcuts to being successful in investing.
- Word-of-mouth suggestions are often hollow, tied to an economic cycle, or have already passed the best time to buy.
- To have the best chance of success, identify a company with good prospects for growth and identify a price that makes sense.
However, some investors are not willing to do the necessary groundwork and look for a shortcut. Everyone wants an edge when investing in stocks. The market can seem (and be) overwhelming, and any advantage seems like a good chance to score a win.
However, too many investors think shortcuts are the way to success. Often these shortcuts come in the form of a tip from a friend or associate. The power of a personal recommendation is compelling, even if the suggestion is coming from someone who may know less about investing than you do.
In days passed, such "word of mouth" information was shared at the office or over the backyard fence. Now, it lives on social media sites, email, and a myriad of other information technologies. What hasn't changed is why you should ignore most of these helpful tips. A good rule of thumb is: Never buy a "great stock."
What, you say? Doesn't every investor want to own great stocks? Of course, they do and so do you, but the "great stocks" we're talking about are usually the ones that a well-meaning neighbor or co-worker tips you off to as the next Microsoft or whatever.
These Stocks Fall Into Three Categories
- Christmas tree ornaments: All shiny on the outside but hollow and easily broken at the slightest touch, they capture the attention of investors easily distracted from sound investing principles with their glitter but ultimately fail because they are not viable businesses. In six months, no one will remember their names.
- Bicycles: What your friend doesn't realize is that this stock is tied to an economic cycle, which is about to swing in the opposite direction. They bought the stock when demand was high and the stock price had inflated rapidly. It may be that demand will soon wane and the price is going to deflate like a leaky tire.
- Great, but late: Your friend is right about the stock; it is great. Unfortunately, the market has bid up the price past the point where you can realistically expect to make any money. It is the "buying high" part of the equation that results in losses (buy high and sell low).
There are two parts to making a good investment decision (assuming your goal is to hold the stock in your portfolio for some period). The first part is to identify a company with a sound business and good prospects for future growth.
The second part is to identify a price that makes sense for where the company is and where it is going. You have to pay for both. The trick is to not pay too much for either. Although there are numerous formulas to help you determine current and future value, figuring out the right price to pay for stock remains as much art as science. However, part of learning to invest in stocks is developing a feel for what makes sense.
Take a Pass
When you are investing hard-earned dollars, it makes sense to take your time and get comfortable with your decisions. If a stock doesn't "feel" right, take a pass. There are many opportunities, so you don't have to jump at the first, second, or twentieth stock you analyze.
If you pass on a friend's "great stock," and it turns out to be a home run, congratulate them for their good fortune, but don't second-guess yourself. For every home run, there are 20 strikeouts. A wise investor once said, "One of the best ways to make money in the market is to not lose it."