Thursday, February 11, 2010

5 Rules for Successful Stock Investing

I have been reading 5 rules for successful stock investing by MorningStar. Here are the 5 rules:

1. Do Your Homework
2. Find Economic Moats
3. Have a Margin of Safety
4. Hold for the long haul
5. Know When to Sell

Do Your Homework

The common mistake investors make is failing to investigate a company before they buy the shares. Take time to understand the business inside and out. A certain amount of accounting skills will be required to understand the financial shape of the company too. The time spent on research can also be treated as a time to cool-off from the stock market where the pressure to purchase the stock immediately is so great.

Find Economic Moats

Economic moats are basically used to describe a firm's competitive advantage. This is the same way medieval castle kept invaders at bay. An economic moat keeps competitors from the profits. A key question to ask is this: How does a company keep its competitors at bay and earn consistent profits? The answer to that question is the economic moat.

Have a Margin of Safety

Finding a great company is only half the battle won. Make sure that the price you pay is not too high. As they say: " Price is what you pay, value is what you get". The goal then is to buy stocks for less than they are actually worth. This can be at low price earning ratios (compared to historical P/E) or at significant discounts to the company's asset value. Sticking to a strict valuation discipline help avoid blowups and improves your investment performance.

Hold for the Long Haul

The cost of frequent trading will drag down your performance over time due to brokerage fees. Treat your stocks like major purchases and hold them for the long term.

Know When to Sell

Don't sell just because the stock price has gone up or down. Some questions to ask:
  • You made a mistake buying it in the first place
  • The fundamentals has deteriorated
  • Too much money in one stock
  • Stock has risen well above its intrinsic value
  • Better opportunities elsewhere

So there you have it. 5 simple rules for successful stock investing.

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