10 Principles on Successful Investing
Vadevalor & Our Principles
Read about Vadevalor and our principles on successful investing…
It is extremely important to understand what drives the stock market in the long term. Once this knowledge is clear, the success of a value investor will depend on his or her capacity to value companies. This requires comprehensive knowledge in accounting and sound analytical skills, accompanied with long hours of research in order to make good forecasts about the future profitability of each firm. For example, Warren Buffett spends around 80 percent of his working day reading and thinking.
In addition, it is also important to realise that value investing is a necessary, but not sufficient condition for success. As well as making the effort to understand companies, future estimates must be accurate to a high percentage. Successful investors have historically achieved this and that is why it is worthwhile to learn from them and monitor their results.
Easy and Predictable Forecasting
Finding businesses which are easy to understand and predictable. An investor must focus on companies in which it is possible to make solid future forecast from observing the past and present.
Doing research to know the business inside out. Reading the public filings, talking to managers, customers and suppliers, reading analyst reports, company news and anything else useful. The process is easier if you are already a customer of the company.
Finding companies with competitive advantages. Competitive advantages allow a small number of firms to retain above-average levels of profitability for many years. Those companies offer a high return on capital. They have pricing power and a strong market position, which can be given by strong brands, lower cost of production, access to resources, superior production technology, patents, switching costs, network effects and so on.
Concrete Financial Profile
Finding companies with a solid financial profile. Debt magnifies financial results when things are going well, but excessive debt can cause a lot of trouble in periods of instability. That is why it is better to be conservative and avoid companies with too much debt
Value for Shareholders
The company management team must generate value for shareholders, have a good track record allocating capital and be honest. In many companies there are huge conflicts of interests between shareholders and management - investors should avoid those firms. There are usually less conflicts of interests in family companies or business with a strong long term investor.
Margin of Safety
Having a margin of safety. The difference between the market price and the estimate of value is the margin of safety. It is possible to compensate uncertainty by buying stocks only when they are trading for much less than the estimates of what they are worth. That will soften the effect of possible analysis mistakes or unforeseen future scenarios. Therefore, an investor not only needs a good company and a good management team, but also an attractive buying price. Great companies are only cheap when there is bad news about the company, its sector or the economy. It is important to understand how these factors are going to affect the future performance of the firm and take advantage of the situation if the market is overreacting to short term negative circumstances to invest for the long term.
This could be the most important principle and it is related to the previous principle. Never paying more than what you think the business would be worth in a very bad scenario.
Holding for Long Term
Trading frequently results in commissions and more taxes and expenses that could have been compounded. Also, your investment period should be at least longer than 5 years (ideally more) and you should only invest the money you know you are not going to need in that period.
Knowing When to Sell
There are four main reasons why an investor should consider selling their part of the company (shares): If they missed something when they first evaluated the company, if the fundamentals have deteriorated, if the price of the stock has increased above the intrinsic value or if there is a better investment possibility.
Short Term Decline
Being prepared to bear a big short term decline in the value of their investments in the short term. Those who could not bear it should NEVER invest in the stock market. Even if the analysis is right and the company performs the way investors expect, the market can panic in the short term and stocks can decline by more than 50% in a short period of time. Historically, that has happened in some occasions and will surely happen again. Investors should stick to their valuations and if they are right about the money which the business is going to generate, their long term returns will be as good as they expect, or even better if that allows them to buy more shares or if the company decides to do opportunistic acquisitions or buy back shares.