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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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The first mistake: investing without a plan or using the wrong investment strategyWhat is life? It is the flash of a firefly in the night. It is the breath of a buffalo in the wintertime. It is the little shadow that runs across the grass and loses itself in the sunset. Crowfoot I LOVE THE ABOVE QUOTE BY THE GREAT INDIAN CHIEF CROWFOOT. IT is a constant reminder to me to not waste my or anyone elses time. Time is a precious commodity and one that we all run out of far too soon. Crowfoots quote made me realize as I reached Social Security age that if I was ever going to give back some of the knowledge I had learned in life and in business, especially in the stock market, I had better start now. My book is a unique look at contrarian investing, designed to help the individual investor make money in the stock market, and most importantly, not to give back his or her hard-earned gains at market tops. In the following pages, I discuss different investing styles, solutions to mistakes that many investors make in managing their money, how to follow The Vital Few (corporate insiders), and how to avoid getting mislead by so-called experts who incorrectly influence the masses or The Trivial Many. I STARTED MY CAREER IN THE INVESTMENT BUSINESS IN 1966. Over the years, it became clear to me that many investors, individual and professional, consistently lost money in the stock market. For the first 10 years of my career, I was also in the losers camp, selling out at the bottom and buying in at the top. I always seemed to do the wrong thing, especially at market turning points. After discovering there were investors who always seemed to be stock market winners, I decided I would devote my life to finding ways to ferret out these smarter investors. I named them The Vital Few. In order to compare what The Vital Few were doing at key stock market turning points to the actions of the consistent losers, like myself, I needed to find ways to monitor the losing investors. I named this group The Trivial Many. Soon after I had learned how to monitor both The Vital Few and The Trivial Many, I became a consistent stock market winner. It really was not that difficult. The hardest part was admitting to myself that I was, in fact, a stock market loser. After I had accepted that fact, I was determined to find out why and how to correct the problem. I am confident that my book will give you a new way of looking at the investing world, especially the stock market. Since uncovering the secrets I outline here, it has been a lucrative and interesting journey for me. I am confident it will be for you as well. Key Reasons Investors Lose Money THE STOCK MARKET DECLINE IN 2001 AND 2002 CONVINCED MANY investors that the market is an impossible place to make money consistently over time. Nothing could be further from the truth; actually, it has never been easier. Before I tell you my secret to becoming a consistent winner in the stock market, we need to examine some of the key reasons investors lose money. The first mistake: investing without a plan or using the wrong investment strategy. Many investors have no plan for making money in the stock market. Others use the wrong strategies because they fail to see changes in market trends. Sports teams, corporations, and organizations that achieve success always work from a fundamentally sound plan. It is no different for those who want to succeed in the stock market. In golf, the most important part of the game is to develop a pre-shot routine that includes good balance and setup. At the golf club where I play, I frequently see PGA golfers in the exercise room working on their setup and balance. It is amazing to me just how still they can be on a small balance beam. Investors, like golfers, need a consistent routine as well. In the financial world, this is known as an investment style. There are three basic styles of investing: value, growth, and momentum, and there are many variations within these styles. The most common investment style is value investing. Value investing offers the lowest risk of any other style of investing. Value investors are known as bargain hunters, looking for stocks priced low in comparison to the companys historical earnings and growth prospects. The most common strategy for a value investor is to buy a stock when it is undervalued relative to its earnings history and prospects and then sell it when it is fully valued. With a long-term approach, the value investor will see many stocks go through cycles of overvaluation and undervaluation. Undervaluation has been the key to success for Warren Buffett and his company, Berkshire Hathaway, whose shares began selling in 1967 at $12/share. The worlds most famous value investor once said, The most common cause of low prices is pessimism ... sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. Its optimism that is the enemy of the rational buyer. Unlike Warren Buffett, who is a bottom-up stock analyst, I have always been more of a top-down strategist. This puts me at a disadvantage when it comes to buying depressed, undervalued stocks. I am simply not as well trained in security analysis to ferret out undervalued stocks as Buffett and his analysts are. Analytically and financially, I am no match for Buffett. However, I have found that my knowledge of insider trading helps me make up for my lack of traditional analytical skills. When I see a stock on the new low list or one that is being panned in the media, I always look to see what insiders are doing. In the 1980s, I was perusing a friends copy of Value Line. I noticed that Global Marine was listed as a 5, a strong sell signal. The Value Line analysis indicated that the stock had a terrible balance sheet and had negative cash flow. I was not sure at the time what that meant, but it sounded bad. In those days, I had no historical insider data on stocks and there was no Internet to check insider trading. I did, however, have access to insider trading reported to the New York Stock Exchange. I discovered that six insiders had bought approximately 275,000 shares in the $3 area. I reasoned that if these insiders were buying a stock with such bad fundamentals, maybe there was something going on that was unrecognized by traditional Wall Street research. Three years later, I sold the stock at $27, just about the time that Value Line had raised its rating to 1, its strongest signal, citing the companys improved fundamentals. Value Line was right, and the stock moved up another 30 percent. I have never been a great seller, but I like making the easy money by getting in early. Income investing is a form of value investing that deserves mention. Also known as dividend investing, this is a straightforward strategy designed to pick stocks that provide a steady stream of income. There are two types of investors seeking incomeequity income investors who buy stocks that pay dividends and fixed income investors who buy corporate and municipal bonds and other fixed income alternatives. Typically, income investors focus on the dividend yield of well-established companies with very predictable earnings streams. The risk of buying historically high dividend paying stocks and holding them for the long term is very low. Dividend distribution and the levels of payouts, however, depend on the retained earnings of the company. It is always wise to make sure there is a large spread between a companys latest 12-month earnings and the amount of the dividend. Cushions are great to rest your head on, and a good cushion between the amount of earnings a company makes and its projected dividends can help you sleep comfortably. Growth investing is the practice of buying fast-growing companies with high potential. The basic strategy for a growth investor is to buy a company with gains in earnings per share of 15 to 20 percent annually. Many growth investors are drawn to the high-tech industries such as telecommunications and the Internet with aggressive management, such as Intel and Microsoft, and innovative leading technology companies. Young companies with top-notch management, often creating superior brands like Internet leaders AOL and Amazon.com also attract growth investors. Most growth stocks, however, are very risky because of the publics willingness to pay premium prices, which inflates the P/E ratios. Vulnerability to changes in perception of the growth potential or to a downtrend of investor confidence in that growth can cause the P/E ratios of these stocks to drop dramatically. The companys industry may play a part in the risk level as well due to varying growth averages and valuations. Stock selection is the most important factor in the strategy for growth investors, using screening programs filtering projected earnings growth against historical earnings. |
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