As in most disciplines, it is wise to go back and cover the
basics from time to time, if only to strengthen the foundation. As we move into the month that has been, historically, the worst for stock market performance, these helpful reminders are designed to do just that. They can help to empower you to keep your cool, manage your
portfolio with confidence, and avoid unnecessary and costly mistakes. Print this article, grab a cup of coffee, sit in your favorite chair and read each point out loud.
1. A corporation is merely a conduit through which the owners of the business (the shareholders) manage their collective capital
Disney World is not owned by the Walt Disney Corporation per se; instead, it is owned by the stockholders - everything from the original Pirates of Caribbean ride in Anaheim to the pencils in the desk of the company’s executives. The result of this business-oriented thinking is that you are likely to make more rational decisions. If you owned 300 shares of Yankee Candle, for example, you need to think of yourself as owning 100 percent of an enterprise that earned $504 during fiscal year 2005. This approach can reduce the tendency to panic in the event of short term shocks such as a
recession or
bear market.
2. Overall growth is meaningless
The overall
growth of the company is meaningless. What truly counts, as we have been reminded by the great minds of finance over and over again, is the per share growth. Too many companies forget this and it is the shareholders who suffer the consequences; Krispy Kreme is the latest example. To see how per share intrinsic value can be increased, read
Stock Buy Backs: The Golden Egg of Shareholder Value.
3. Don’t pay for hope
Any time the success of your investment depends upon above average rates of growth for long periods of time, you’ve stripped away the
margin of safety that could otherwise protect you in the event of short-term unfavorable developments in the business. If you’re fine with this sort of precarious situation, so be it; just make sure you don’t commit money you require for important life milestones such as funding an
education, purchasing a home, or supporting the
retirement of your dreams. You won’t fine very many opportunities where the growth isn’t factored into the price of the stock, but if you look long and hard enough, you will encounter a few in your lifetime. Lucky for us, that’s all it takes to become wealthy.
4. Although it is often true, risk and reward are not always correlated
For example, a middle manager at a refining company would have known in the late 1990’s that $10 per barrel oil was not sustainable. As a result, he could have made a large investment in oil production companies and refiners – businesses such as Exxon Mobile or Valero – and reaped huge
profits without taking on any excess risk. Today, it is likely that he would have made many hundreds of thousands, if not millions, of dollars. Contrast that to a situation such as USG where the business will be extremely profitable if Congress solves the asbestos crises.
5. If you are uncertain about an investment, sit it out
There is no shame in admitting that you do not understand an investment. In fact, billionaire investor
Warren Buffett once mentioned that he didn’t invest in Enron because he couldn’t understand the footnotes in the financial statements. That ability to recognize his lack of knowledge and willingness to move on to the next opportunity saved the shareholders of his holding company, Berkshire Hathaway, from suffering loss.
6. Steer clear of managements of questionable integrity
No matter how attractive the issue, it is almost always a mistake to go into business with dishonest people. It may be okay to wade into the water once those responsible for corporate malfeasance have been rooted out and discarded, but be reasonably certain that the corporate culture that gave rise to such actions is no longer at work.
7. Ignore short-term fluctuations
Movements in the quoted price of your investments are meaningless except in that they allow you to add to your holdings at attractive, lower valuations and sell your holdings at rich, higher valuations. As Graham said in
The Intelligent Investor, to allow yourself to become perplexed by these movements is to become emotionally tormented by mistakes in other peoples’ judgment!
