1. Focus on the Intrinsic Value of Companies â€“ This is by far the most important rule for the value investor. Intrinsic value can be defined as â€œthe actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value.â€ Value investors look at the fundamentals of a company NOT THE TECHNICAL ASPECTS OF A STOCK. And as history has shown, value investors outperform technical traders in the long run. The key here is to buy stocks at levels that are below the level of intrinsic value for a particular company. This not only provides a margin of safety but also the opportunity for gains when the market corrects itself.
2. Practice Emotional Stability â€“ You do not need to be overly intelligent to be a good investor, but you do need strong emotional intelligence. Very few investors have made substantial money by getting caught up in market â€œswingsâ€ (although there are many who have lost money). As a value investor you should already be buying a stock at a level that is below what the company is actually worth, so if the stock goes down, all that means is that you can now buy even more of this company at a better price! Do not sell just because the price has dipped if the price of a stock is still below the value of the company. On the other side of things, just because the price has gone up does not mean that you should sell! A value investor should only sell once the price of the stock has surpassed the value of the company. So if the price has gone up but the price of the stock is still below the value of the company donâ€™t sell! There is still some money to be made. If you donâ€™t think you will be able to handle this donâ€™t invest in the stock market.
A great example of not having emotional control comes from â€œThe Intelligent Investorâ€ by Benjamin Graham. In the Spring of 1720, Sir Isaac Newton, one of the great geniuses of all time, sensed that the stock market was getting out of hand and dumped all of his South Sea Company stocks (one of the hottest stocks in England at the time). He pocketed a 100% gain totalling 7000 pounds. However, months later, by getting swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price, and subsequently lost about 20,000 pounds (which is over 3 million by todayâ€™s standards) :S. Now Newton wasnâ€™t an idiot. But he did not have the emotional discipline that is necessary to be an intelligent investor. So if youâ€™ve failed so far, itâ€™s not because youâ€™re stupid (probably not anyway), itâ€™s because you havenâ€™t developed the emotional intelligence required to be a successful investor. So control your actions! Donâ€™t be a sheep. Be the wolf.
3. Avoid Permanent Losses â€“ Investing is not just about making money, itâ€™s also about not losing money. Enterprising value investors outperform the majority of other investors because they do not lose money. If an investment does not offer an adequate amount of safety of principle (i.e. buying below intrinsic value etc.) then it is not an investment. It is a speculative operation, a big no-no in the value investing world. Most other value investors will say that a true value investor is not concerned with outperforming benchmarks. However, taking my own little spin on things, I believe that over the long term, an enterprising investor should use benchmarking tools (such as the performance of the market indexes) to evaluate their performance, or else there really is no point in putting in the time and effort into researching companies, especially if you are not going to outperform the market in the long run.
4. Diversify Less â€“ Today all you will hear from the majority of investors is to diversify. By now you should know that Iâ€™m not a fan of it (check out my article on diversification) because if youâ€™re already using a value oriented approach to investing diversification will actually limit your gains, as a value oriented approach already provides a margin of safety. There is no point in using two techniques which both provide greater safety. Itâ€™s like wearing two life-jackets when you go boating. Thereâ€™s not really a point in it. SO Iâ€™m actually going to go AGAINST Benjamin Graham here and tell you to diversify less, but only if you are willing to put in the time and effort to research the companies that you invest in (or just listen to the stock picks that I give you
). If youâ€™re not willing to put in the time and effort then yes, you should diversify. But as an enterprising investor, diversification will not even be a part of your vocabulary.
5. Continue to Learn â€“ This is a no brainer. If youâ€™re not willing to continue to learn then donâ€™t become an enterprising investor. You are always going to need to learn about new industries and new companies. Youâ€™re going to do a ton of reading, especially on various companyâ€™s financial statements. And if you donâ€™t understand something in them, then youâ€™re going to have to figure that out. Youâ€™re going to lean about different industries and how they operate, what their average profit margin is, and any threats that may hinder the industry in the future. And youâ€™re going to love every waking minute of it.
Stay tuned for my next stock pick which should be posted in the next few weeks. I know itâ€™s been a while Iâ€™m sorry!
Twitter â€“ JustinG101