Educational Series #1
This is the first of many articles as part of our Educational Series that we are planning. The contents are actually extracted and expanded from our very popular and successful course Cashflow Mastery Program.
Can You Learn Successful Stock Investment Skills?
People invest in the stock market because they are looking for better returns with their hard-earned savings, to make their money work harder than merely putting it in the banks and to beat inflation.
Many people start their investment journey without a so-called “formal” or “proper” training. They pick up stock investment knowledge from their family members, friends, stock brokers, reading books and getting information from stock investment websites and probably watching some YouTube videos. Unfortunately, as you are picking up pieces of information from various sources, sometimes it can be confusing if not misleading.
I started this way too.
You certainly can pick up some good knowledge from the above. I personally also think it is beneficial to learn directly from coaches who have the experiences and track records of consistent returns and have a systematic methodology of how it is achieved.
Different people learn differently, some can pick up knowledge and skills from reading books while some need one to one coaching.
There are a number of well-known and successful investors who have made fortunes from the stock market, the notable ones like Warren Buffett, his business partner Charlie Munger, author of One Up On Wall Street Peter Lynch and many more. Warren Buffett himself learned from Benjamin Graham whose famous book The Intelligent Investor lays the foundation for Value Investing.
Warren Buffett is the richest person in the world who makes his riches from equity investment and his returns consistency is over a long period of time. We can always learn from the best in this game.
Wise Stock Investment Principles
There are a few key principles of investing that we can learn from Warren Buffett and Charlie Munger and these are:
- Know the companies you are buying into (or circle of competence)
- Do they have competitive advantages (or economic moat)
- Is the management team good enough
- Buy with a discount, or margin of safety
These seem very simple and common sense but they are words of wisdom. We will explain some unfamiliar terms as we go along.
We use the Stock Investment Framework below which we have designed to provide a step-by-step process flow incorporating these principles.
In summary, the framework comprises 5 steps:
- Stock Screening – There are many stocks listed in every stock exchange. How do you go about hunting for the right ones to pursue? “Invest only in companies you know and trust”. Each of us is trained in a particular field, work in a particular sector and we have our own circle of competence. That’s definitely a good area to start with. Other considerations include whether you want to go for big market cap or small market cap or which stock exchange.
- Fundamental Analysis – This step involves dissecting the company, understanding if it has a great economic moat, if it has a good management team to steer the company in the right strategic direction and delving into its financials such as earnings strength, profit margins, cash flow positions, return on equity (ROE), debt level etc. “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonder price”.
- Valuation – To me this is a very key step but sometimes the calculations can be daunting. You want to know the intrinsic value of a particular stock and there are a number of valuation methods available, from a simple look at the PE ratio to such concept like the Discount Cash Flow method. “Price is what you pay. Value is what you get”.
- Market Entry – A stock price lesser than the intrinsic value you have computed should signal you can start buying the stock. However, you might want to build in a margin of safety (MOS), a term popularized by Benjamin Graham, Warren Buffett’s mentor. Calculations are not going to be exact, so allow some margin of errors. “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1”.
- Market Exit – If a company is always growing or always consistent in generating a great level of earnings, then in theory, you will never want to sell it. Review your stock portfolio regularly and take actions when there is some change in the company’s fundamentals or the price has really gone up too high. “Our favourite holding period is forever”.
In today’s article, we elaborate on the Stock Screening Process.
There are thousands and thousands of companies which are publicly listed and traded on exchanges around the world. How do you take the first step of deciding which company you may be interested to invest in?
Well, one of the stock investment principles that Warren Buffett suggests is to only invest in what you know or what you understand. The rationale is simple. When you buy the shares of a listed company, you are in effect buying partially a business with the key objective of making a profit from your investment.
If this is the case, would you buy a business that you do or you don’t understand? Clearly, you would want to know the company’s products or services, the customers they are selling to, the competitive landscape, whether the company has a well-known brand, how it does its marketing to retain existing customers and attract new customers and so on.
Keeping to what you know is known as keeping within your circle of competence. A simple way to help you figure out your circle of competence is the following exercise.
From here, you can discover companies that you are already familiar with because you use their products (e.g. particular brands of toothpaste), or where you spend your free time indulging in (e.g. watching Netflix) or you the companies because of your profession or training (e.g. Facebook and Google because you work as a digital marketer). If there is some overlap of the three circles, that will be a sweet spot of industry of companies that you probably know quite well, better than others to derive better insights into the companies’ performances.
Following this principle, when you are researching into companies to invest in, you are not starting from scratch.
Other than considering your circle of competence, you may also want to consider a number of other issues. I personally like to invest in higher market capitalization (total number of outstanding shares multiplied by the current share price) stocks. The main reason being there is more information that is available regarding these companies. There are investors who do the opposite, researching hard into smaller market capitalization good companies, with hidden values yet to be uncovered.
You may also want to decide whether to only invest in stocks listed in your home stock exchange. Various brokerage firms allow you to trade stocks listed in other countries, but take note of additional exposure in the form of currency fluctuations. I personally invest in stocks listed in Singapore, US and Hong Kong.
Ultimately, when deciding whether to invest in any particular company, you need to know the company well enough, not only its past performance but also its performance into the future. As there are so many listed companies that you have access to, drop those that you are not comfortable with.
Even Warren Buffett has a document tray called “Too Hard”, discarding stock picks which he does not understand, so we should do the same. After all, for retail investors like us, we only need a portfolio of around ten really good companies and hold them for the long term.
We hope you enjoy reading this first article of the Educational Series, do look out for our next article where we will explain in lay-man terms how we can understand financial statements before we delve deeper into Fundamental Analysis.
At Journey With Money, we are practitioners of Value Investing for Singapore and US stocks. We are passionate about sharing our Stock Investment knowledge and experience but the materials we present do not constitute stock recommendations and readers are urged to do their own due diligence for any investment decisions.
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