Many people, perhaps the majority, invest in stocks as if they were lottery tickets. They hear something positive about a company and its potential, and they throw money into it hoping to get rich. But a stock is not a lottery ticket. It is an ownership stake in a business that happens to have the added benefit of being highly liquid. That is all. It follows that long-term success in the stock market only comes from investing according to the same principles that work in business.
The first of these principles is to know your business. If you are investing in a company expecting the stock price to rise, make sure you understand exactly which drivers will produce that result. Make sure you understand the external and competitive risks the business faces that could knock it off course. If you own it, it is your business. Just as you would want to understand every detail of a small shop you hypothetically owned and operated, you should be an expert on the businesses you invest in.
The second principle is that only you know what is best for your money, and you alone bear responsibility for how it is managed. Do not become passive by letting someone else manage your money or make decisions for you, unless you have strong reason to trust them. This means not investing in an asset simply because someone tells you it’s a good opportunity. You must do your own due diligence to justify straying from easy, passive index funds.
The third principle is to make sure the price of the asset is reasonable from an owner’s-value perspective. Anything is a bargain at the right price, and a rip-off at the wrong one. The further the price strays from the business’s current and likely future performance, the more likely you are to lose money to unforeseen circumstances. Conversely, the closer the valuation sits to intrinsic value, the less likely you are to lose money.
Finally, the fourth principle is to trust your own judgment. Assuming you’ve done the upfront work to form a strong opinion, don’t let the concerns and illusions of the crowd talk you out of it. The opinion of the market, the masses, and the media has no bearing on whether something is true or false. If you’ve done the work, it’s very likely you know more than the general public. Making money in the market, by definition, requires being contrarian and thinking differently. If you’ve built genuine conviction through your own work, act on it.
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Buffett’s 4 Purchase Decision Criteria
Link Explanation: It is easy to see the direct relationship between Buffet’s four investment criteria, laid out in his letters to shareholders, and the owner perspective laid out by Graham. The first and fourth of Buffet’s criteria, can be effectively squeezed into the first principal above. Know your business. The second of Buffet’s criteria is almost the same as Graham’s second. At the end of the day, the management of a business is a steward of the shareholder’s capital. Just as you wouldn’t give your money to some shady wealth manager, you should be cautious giving your money to a management team that doesn’t understand their own responsibility. The third of Buffet’s criteria is the same as Graham’s third. Buy the business at a discount. And the fourth, while not explicitly mentioned by Buffet, is obviously followed by him when he has made massive bets in the past on American Express, Coca-Cola, Apple.