The short disclaimer:
- This is intended as a loose guide for absolute beginners, but I think intermediate investors may find some good things to ponder.
- To get this clear — I am not a financial advisor (obviously). I am certainly not a stock market expert, and I strongly believe you should not trust anyone who claims to be.
- Stock prices go up, but they also go down — you can lose all your hard earned money if they don’t recover.
- I strongly recommend you do your own research before you part with any of your hard earned money.
The longer disclaimer:
I wrote this because I am interested in helping people like my younger self get a foot in the door investing. The stocks I mention in this post are used for explanation purposes only, so please don’t herp-and-derp to a broker and buy them just because I mention them here.
A lot of people I respect have been asking me about my ‘stock market’ tweets recently, how to invest, how it works, how to pick stocks, avoid getting burned and so on. This post then, is for people like you and me many years ago, who had no idea about investing in the stock market beyond knowing that a stock was a part of a company you could buy. I hope I can answer those questions for you — I will discuss my personal strategy and how I came to it based on years of my own research. I have had decent success, more than I ever imagined I could when I got started, so I’m confident you can do better.
Furthermore, as you may already be picking up on… I need to point out that I am pretty shit at writing. This took an awful long time to write and put together and it may be laughable to those of you who have far more experience with writing and or investing than me. It’s really long, and probably boring for the most part; but I hope that you can suffer me long enough to read it in full and by the end, you leave with the intention of learning more to ultimately help yourself and your family become more secure financially.
You don’t need to be rich to begin with, nor highly intelligent. (Fortunately for me!)
To make a lot of money with basic stock investments in your lifetime you need a good strategy, confidence, and above all — patience. The first two can be learnt, but patience is what will be the crux of your success on the markets. The concepts and information I will go into wont make you rich quick. They wont make you rich on their own — the whole point of this is to show you where the yellow brick road lies, you MUST do your own research to become Dorothy. The first mistake people make when investing is following the crowd; taking advice and information at face value without questioning it, then blaming the messenger or the market for their mistakes (more on this later.)
It really isn’t as complicated as you think, and it’s only as risky as you make it.
If you can design a website, you are more than intelligent enough to be investing. You will do fine over time as long as you follow a few key ideas and research your stock picks carefully. I wont be going into boring mathematical depth here, nor is this a charts and day trading strategy. But I will link to various in depth sources of useful information when I feel they are important, so if you would like to go deeper (and you should), you can. I fucked up many times along the way and I want you to take my fails as warnings.
I also wrote this with the assumption you understand the terminology of what ‘stock’ is and at least some very basic understanding of what ‘stock market’ means… Essentially, a Stock is a piece of a business that can be bought on the Stock Market for a price that fluctuates up and down. Owning a stock means you own a tiny piece of that company and it’s assets. I highly recommend you take a look at this video to grasp the terminology quickly. She has many other great videos, too.
Investing has many forms, there are many different types of securities you can buy, but I will be talking exclusively about Stocks and touch briefly on index funds here because those are exclusively what I know and buy personally. I am a long term ‘value investor’ myself, I do not care for nor have information on short positions or day trading etc. I like to buy Stocks in good companies, and reinvest all of the profits gained over time.
The younger you are, the better this will work for you.
If you are below the age of 25, excellent. If you are an old fart like me, don’t worry, it’s not too late to start (or an excuse!). I have put off writing something like this despite being asked a lot because of two factors. The first being impostor syndrome, the second being the experience that talking about finances, incomes and especially investing tends to attract a lot of salt. A lot of people just tend to get mad if someone else appears to be more secure with finances than they feel they are or assume they should be. Couple those with the internet being the ultimate shitlord magnet it tends to be, I was worried if I started writing about this stuff I would be picked to shreds by people that know better than I, or less than I, for one of these reasons. Please, don’t be that person, and don’t take my word as gospel.
I mention Warren Buffett and Charlie Munger a lot, so you can rightly assume a lot of the methods I talk about can be traced back to those highly successful investors for credit. They made their fortunes with the ideas I shamelessly copied for my own investment strategy too. I will start with some concepts you need to understand, then we will get into identifying stocks that fit those concepts. I hope you find a sentence or two in here useful. So, grab a coffee and lets get into it (spoiler: it’s a long read)
Part 1: Compound Interest
Fortunately, you don’t need to be as bright as Albert to get rich, and compound Interest is the first key to the gates of your financial freedom.
So what is compound interest? In basic terms relevant to this post, it’s money earning money without any work. Sounds too good to be true. It’s the idea that, if you leave money earning a return for long enough, you end up with a huge pot, far larger than you may realise over time.
For those of you that ever took a maths test as a child years ago, prepare to cringe at the following example — but I need it to be really simple to be effective. If you take £100 and put it into a pot with a 5% yearly return, you will have £105 at the end of the year. Great. “Mum, I made a fiver!”
The mistake then would be to think “lets take that fiver and spend it.” By doing so, the £100 will only ever grow by £5 per year. However, if you take that £5 return and reinvest it back into the pot — it will grow to £110.25 ish the following year. So after two years you made £10.25 profit from your £100 starting pot. Still, not very impressive.
The takeaway from this example is that; if you reinvest what the money earned on its own, your pot grows.
Your initial 100 quid turned into 110.25 after 2 years. Therefore, you compounded your profit of a fiver, and thus earned slightly more interest the following year. For the sake of keeping it enticing, lets change the numbers and circumstances around a bit.
Lets assume you invested £8,000 into a stock that returns 10% per year by 20 years old. You then do absolutely nothing other than reinvest the profit it makes at the end of each year. By the time you retire at 67 your initial £8,000 pot has compounded and grown on it’s own to around £1.2 million. Retirement sorted. Obviously there are taxes and inflation to consider once you sell and cash in, but you get the idea.
“Excellent, so I’ll be the richest man in the graveyard. How does that help me now?” Well, this basic example is only assuming you invested £8,000 once and never touched it again for 47 years. Some more savvy among you might be asking “‘well where can I find returns of 10% a year in today’s market?” Valid, which we will get to later.
My point is, If you continued to invest more capital manually on top of the compound interest year on year, you are significantly multiplying your returns and It quickly snowballs. On average, the longer a large successful public company is trading, the less risky it becomes and the value of the stock increases over long periods of time. You need only to look at a long term market tracking chart to see the markets constantly rising and falling in the short term — but rising overall in the long term. (Again, more on this later.)
It may make you wonder if it was that easy, why doesn’t everyone do it? Well, it sounds easy… and why are you here? My guess is, many of us go through life oblivious to the fundamentals and concepts of stock markets, considering them too complicated and too risky. For many people, they never get past that. In fact, if I hadn’t stumbled across the book ‘The Snowball’ by Alice Schroeder right after the 2008 financial crisis, I would likely have never even considered putting my money to work for me either. A great book by the way, and you should read it. It’s the life story of arguably the most successful investor of all time; the Oracle of Omaha himself, Warren Buffet. Buffet earned his fortune with his holding company Berkshire Hathaway, buy stocks and other companies, based on a set of principles that made Buffet a legend. A single Stock of $BRK-A will set you back over $210,000.00 today.
Buffett is one of the richest men in the world and, while I will never achieve his wealth or success, I took a lot of his core ideas to help me choose what stocks to buy. It goes without saying Buffett has a knack for identifying good companies and is an incredibly intelligent chap who anyone can learn from.
Part 2: How do I know what stocks to buy?
“Risk comes from not knowing what you are doing. What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know.” — Warren Buffett
First, Lets try and discuss some of the thoughts I had when I first wanted to buy stocks.
“I worked hard for this money, I don’t want to lose it.” If you feel like this, you are exactly the kind of person that should be investing. If you keep money in a bank account, it actually depreciates over time because of inflation. If you are fortunate enough to have a sizeable cash saving, you can surely half it down and put the rest into stocks to make it grow.
If you are thinking “I want to make as much easy money as I can as soon as possible”. I’m sorry mate, but you are heading for a rough time in the market. In fact, many significantly smarter people than me make an insane amount of money screwing people with that mindset on the market, leaving them holding the empty purse. At this point, we need to delve deeper about how we can reduce the risks and stay away from things we don’t know.
First, you should be looking for a company that is uncomplicated.
Some of you who follow me on Twitter may be thinking “didn’t you just tweet about buying Wells Fargo stock? isn’t banking really complicated?” My answer to this is; Uncomplicated to you personally. There is no ‘absolute’ measure of how complicated a company is, what I am getting at here is that if you don’t understand the company you are investing in, you are basically pissing in the wind, and your capital is at a significantly higher risk than it needs to be. If you are an expert in financial derivatives, pharmaceuticals or energy companies; you can invest in those companies with a lower margin of risk — based on your knowledge. I’m sorry for going on, but I don’t think I can emphasise this point enough — so one more time:
If you don’t know how company does things, when inevitable circumstances arise which stop them from being able to do those things, you are fucked.
A wonderful example of this is what is known as the ‘Dot com boom’ and the ‘Dot com market crash’. Vast amounts of people piled into radical new technology companies which, at the time, no one really understood yet, and thus created a huge speculative bubble. Since very few people knew if these early tech ‘unicorns’ would ever make any money (and surprise surprise, a lot of them didn’t). People gambled and lost decades and lifetimes worth of wealth accumulation in a matter of days when bubble burst… Many would argue that times change — but don’t forget, history repeats itself. Often.
Times have changed a bit now though, at least in terms of tech companies making money (unless you are Twitter — despite filling my timeline with shit). For example if you invested in Facebook at it’s somewhat recent May 2012 IPO price of $38 per share, you would have almost tripled your money by mid 2016. Facebook makes good money as do many other big valley corporations; the hard part is identifying them. Easily the most difficult part of investing and the hardest part of this post for me to write.
Fact of the matter is, even if you are the best company in the world with the fantastic profits, or the most experienced financial advisor or hedgefund manager (which I certainly aren’t), it could all be over tomorrow. There will always be that risk, because yay capitalism.
“So how do we deal with that risk?” Hard as fuck to put into practice and I am, like many others, still trying to learn today. Lets look at explaining some of those core Buffett’esque ideas I mentionned earlier.
Essentially, you need to be finding a Great company at a Cheap price — key words here being ‘Great’ Company, and ‘Cheap’ price. It’s no good to hop onto the market looking for something cheap if it’s a pile of shit, right?
You get what you pay for in stocks just as you do with products. That being said, you are right if you are thinking that ‘good things don’t come cheap’ so I had better start explaining before I lose you…
What made CoCa Cola, American Express and many others Good enough for Buffett to invest, and make a ton of money? It’s important to know that you can’t really make investments in those exact companies work as well for you today as ‘it’s already been done’ in a sense. Those companies are huge now, and while they will still continue to grow and be great companies, they aren’t necessarily ‘cheap’ unless the overall market takes a massive shit, plummeting the price. Buffett got in when the price was lower than it should have been, and made millions when the value went up later. Great companies and Cheap prices. Unfortunately for our 2016 market, it’s a lot harder to emulate Buffetts moves or identify those companies early and before everyone else does, because information is so readily available now thanks to the internet. Furthermore, if you watched Berkshire Hathaway’s recent annual report, by Buffett’s own tongue even he ‘struggles to make money’ like the old days. (that is extremely relative, mind. He still makes about $1.5M per hour!) Don’t let that put you off, though. Even if we have basically zero chance of becoming as good as Buffett in finding %10,000 + returns in 2016, we can still do alright and even great when we apply some rules.
I will not be going into incredible detail on knowing when a stock price is ‘cheap’ in this post because it’s so in depth and prone to understanding a lot of mathematical jargon. We really would be here all day and that isn’t what you want for ‘getting started’. I will touch briefly on it at the end and point you to where you need to research to find best practices to determine more accurately, in the form of other people who can explain it far better than myself. So for now, lets look at how we may identify a ‘Good’ company.
First of all, you want to find a company with a strong brand, ultimately leading to pricing power.
It’s important these two are linked together. Brand is pretty easy to grasp at first take, especially if you are a product designer, but we need to touch on a few things to explain why this goes deeper than having a good logo when you are sizing up a stock to buy.
If I say to you ‘Universal Studios’ it’s likely to take you a a short while to remember or even identify which films they put out. Most people know that Universal Studios is a huge movie company that is successful and whatnot… but if I say to you ‘Disney…’ you nearly instantly get something in your mind. Almost every child in the western world has seen something by Disney — in fact, many adults still love Disney movies and spent awful amounts of money buying and filling their home office shelves with entire Dis… anyway, the point is, Disney is a marvellous brand loved by it’s customers, easily recognisable by it’s competitors, and known for putting out extremely successful products and franchises on the regular.
People pay Apple so much money for iPhone because… it’s an iPhone. Whether you are on board with it or not, the sales numbers show they built an insane brand loyalty that the average company cant even dream of. It’s certainly not always the case, but which company is less likely to be undercut by the competition? The one with the strong brand.
One last note on brand — it doesn’t necessarily have to be ‘big’ in the sense that everyone and their dog knows about it globally (if it is, great). At the least it should ideally be recognised for quality by the industry it resides in. For example, who is an expert on Aerospace Engineering companies? No? Me either, but if you asked the owner of an airline manufacturer who makes the best parts, he would give you some companies to consider.
Good, vigilant management who have a stake in the company.
This doesn’t necessarily mean Jane and John who manage the IT department getting a handful of shares in their pay packet each month, rather the the higher ups with authority that have some meaningful stake in the company ownership. Buffett argues it’s importance because people that run a company they don’t own a slice of tend to give less of a shit when things go wrong and have much less incentive to repair problems until it’s too late. They also need to be vigilant in looking for potential dangers to the company for it to survive long term.
“If you hire people just because they can do a job, they’ll work for your money. But if you hire people who believe what you believe, they’ll work for you with blood and sweat and tears.” — Simon Sinek
Most cases this is true even if you pay them whopping high salary. If you pay them in equity, you could argue they are more inclined to work to raise the market value of said stock. The key is the balance — pay them too much money and they may not care about the company because they banked from the salary. Pay them too much in equity and they may be more inclined to raise the short term price of the stock with risky manoeuvres, and so on goes the argument…
The way I see it, it should be somewhere in the middle. You have to make a reasonable judgement based on the available data. If you can’t your risk goes up.
Good balance sheet. (low debt, high return on equity)
Here is where things start to get hard to follow unless you are familiar with accounting. What this boils down to is a company with a high return on equity (bang for buck in profits), and low debts.
The former is often referred to as ‘ROE’ which just means if you take a years profit before interest and tax, and put it over debt and equity employed during the year as a percentage, you get the return on equity. I highly recommend you watch this video for a further, relatively quick run down of what ROE is and why folks like Munger and Buffett recommend looking into it so much.
For debt in simple terms; if the company owes too much money to various lenders, your risk is higher because they are more likely to get into financial black hole. Personal debt is awful, and company debt isn’t great either so were looking for companies with as little of it as possible.
The lower the Return on Equity and or the higher the Debt to Equity (great video here) that a company has, the higher the risk to invest. The man who has no debts rarely goes broke.
The company profits must be backed by solid cash flow, not relying on accounting magic.
This is sometimes referred to as ‘cash cover’. Basically you need to check that the operating profits in the company aren’t some sort of accountant team alchemy. An easy way to do this is to look at the company’s income statement and make sure that operating profits line up relatively close to it’s cash flow.
The takeaway being to avoid companies that have seemingly high amounts of profits, and basically no cash.
Durable Competitive Advantage. Aka, the “Moat.”
Tricky to pin this one down but with a little research, you can find companies which have the “Moat”— it’s actually a term Charlie Munger uses to further describe a company with a crazy competitive advantage.
So what are examples of competitive moat? Well, the previously mentioned ‘strong branding’ can be one. Companies can have many different types, and the more they have, the better.
A more distinctive competitive advantage can be in the form of industry regulation, or even as simple as company size. For example, I will discuss a Stock I personally own.
The largest natural gas pipeline company in the USA — Kinder Morgan — also owns and operates the largest natural gas pipeline, connecting all major natural gas resource basins to market centres. Because of that it has unrivalled access to supply its customer’s gas to the best markets so they can fetch the best prices. Additionally, they are the biggest independent transporter of petroleum products and carbon dioxide, as well as the largest independent terminal network operator. This huge size and scale enables Kinder Morgan to meet customers needs better than anyone else in their market. Finally, it controls the only oil sands pipeline shipping oil to Canada’s West Coast meaning it is the only pipeline option Canadian oil producers have to get their oil to Asian customers. It’s basically a legal monopoly at this point. Pipelines are also heavily regulated by governments. In short, Moat moat moat, you need a big boat to cross my moat. (I also got in on the stock when the price took a tumble in February to a price I personally determined was very cheap for the offerings.)
It’s very hard to enter a market that is already dominated and heavily regulated — perfect sharks in your moat. (There are many different types of ‘moat’. Buffett describes it here and you can read more about them here.
Takeaway: Durable competitive advantages, or Moats, mean less competition taking away market share which lowers investment risk.
What does the future look like? is the company innovating?
Great Scott, Marty. The future aspect can be minefield. You absolutely need your company to be around for decades ahead, but you can’t accurately predict 20 years in advance — so you panic and the risk seems enormous. If we take the above points and find all the boxes were ticked thus far, we have to then consider these two.
No one has a crystal ball. We don’t know what new tech is on the way that may render things obsolete, or if a company is doing everything it can to truly innovate on it’s products year on year. Apple had a great run up until Steve Jobs passed away, but then many would argue that their innovation died with him. I believe it was Bill Gates who said ‘Innovation tends to come in short bursts’ or something to that effect, much like creativity. Only one thing about the future is certain, and that it’s entirely uncertain! (despite the best research or predictions from expensive hedge fund analysts and idiots like me.)
However there are some things you can know such as the company plan for growth which they release to the public and shareholders. Whether or not the company will achieve the goals they set out with the strategy they propose is a mixture of common sense and critical thinking for you to make judgement on. This for me is the most fun part of investing; reading annual reports and sizing up the future.
Don’t throw money at a company in the hopes of getting a lot more thrown back one day in the distant future unless you know what their plan for that future is.
Dividend yield and returns.
A dividend is a sum of money paid regularly (usually quarterly) by a company to its shareholders out of its profits (or reserves). http://www.investopedia.com/terms/d/dividendyield.asp
When you analyse a stock, most sites like Yahoo finance will have something called a Dividend Yield percentage near the stock price. It can be 0% which naturally means that the company currently doesn’t pay anything out to shareholders, so the only return you can expect in the short term would be a rise in the price of the stock after you buy it. This doesn’t mean the company will never pay a dividend, it just means that they don’t currently.
On the flip side, If the company pays a dividend yield of say 2–4%, it is simply the dividend amount expressed as a percentage of the current share price. So lets say a stock trades at a current price of $10, with a dividend yield of 20%. Each piece you own will grow by $2 per year. So if you own 2 shares or $20 worth in stock, you get $4 per year back in dividends and so on.
Dividends are taxed differently from country to country so you will need to speak to your tax advisor to learn more about that, sorry.
Dividends also fluctuate with price, and can be cut at any time (sometimes entirely) so you may want to take a look at the company history of dividend payments. You want to look for things like a steady increase in yield over the years, and if they have large gaps which recovered over time. This shows you that the company has a good track record of rewarding shareholders with cold hard cash dividend.
For me, and the compound interest example at the start, healthy dividends form a large chunk of income for my personal stock portfolio, so I don’t typically buy in big on a stock unless it has a yield of 2–7% for the long term. Any higher than 7% is generally considered risky.
High yields may sound attractive at glance, but If a company is paying too much out to shareholders, it reduces the amount of cash it has, therefore chasing high dividend yields can be risky (read). For best results over time, I try to look for dividend yield that sits between 2–7% and shows a long history of payouts that increases year on year.
So, we’re on the home stretch of ‘getting started’. If you see the topics up until this point as a checklist of sorts, you want companies that tick all of those boxes at the very least to make a better investment decision than buying some random stock on the market.
There are many, many more things to consider, but in the interest of you not melting into your chair, I’ve narrowed it down into what I feel is the most important for identifying ‘good’ companies with ‘getting started’ in mind, so thanks to Buffett and his genius.
http://www.investopedia.com/university/ is a great source of information and I highly recommend trudging through it’s free archives for further consideration, as well as the links I have provided in the footnotes. Now, lets talk briefly about the ‘cheap price’ part of that earlier mentioned statement.
Part 3: How do we know if a stock is cheap?
Can you tell how much I admire Buffett yet? Despite being entrenched in many mathematical formulas and exact figures, Investing is not an exact science. It can be argued that the methods to figure out if a stock is cheap or not should be different for each individual investment and rightly so, all companies have different circumstances which require different analysis.
Banks for example are notorious for having accountant armies equal in size to Lord Sauron’s army of Mordor, that cast dark ‘accounting magic’ on their books to inflate or even make numbers disappear entirely. So how the fuck is an average Joe like me to understand complex situations like this?
Discovering value is a pandoras box that many investors have tried (and failed in most cases) to understand for life times. It’s the big snake pit precursor to losing money on the markets.
To begin to step around the hole, one option is figuring out the Intrinsic Value of a stock.
This is a financial term that Buffett uses to size up the price of a stock. When I first started out, I assumed incorrectly that intrinsic value was an exact value. Very fucking expensive mistake so don’t skip this part.
Intrinsic value is actually an estimate. It originally comes from a fellow named Benjamin Graham, author of a brilliant book some time ago called The Intelligent Investor. Graham’s book and philosophy is also the real foundation of ‘value investing’ — something Buffett has repeatedly praised and referred credit to for aiding his success in the markets, and also a key turning point in his investment strategy. Another highly recommended read, though it’s quite heavy, so here is Intrinsic Value in Buffett’s words…
“Intrinsic value can be defined simply: It’s the discounted value of the cash that can be taken out of a business during it’s remaining life.”
What? Don’t worry… he continues…
“As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised. Two people looking at the same facts will almost inevitably come up with at least slightly different intrinsic value figures.”
Buffett has stated many times that intrinsic value is a ‘guide’ rather than a map so to speak. There are various formulas and methods people have put together over the years to try and replicate or line up with Buffett’s definition — so you can start to see why I have zero desire explain this in depth. So… what do? Well, one of the best explanations I found recently is a video series by a guy called Preston Pysh. Well worth watching after reading this. It’s a long series because this is complex topic. Preston essentially puts together a formula you can follow his video series here.
When the author of a Medium post starts dumping quotes and links to more intelligent men, it’s usually time to assume he’s a clueless berk that you shouldn’t listen to. Rightly so squire, but I would like to assure you that if I can grasp the above, so can you. It will just take some time.
I’d like to raise my shield and say again that my intention here is to show you the path, so please look into the workings of these concepts and make sure you understand properly. With that out of the way, lets talk a little bit about P/E before we close this out.
Price to Earnings ratio (P/E)
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” — Warren Buffett
As investors, we want good companies as explained above. We also want that company to be at an attractive price to make a profit. P/E is another popular method to ‘help’ you determine that. (P)rice to (E)arnings is a formula for valuing the company that measures the current share price relative to the per-share earnings.
In modern times, this is figured out for us, and easy to find on the internet — great. Hop on to Google and search for ‘$KO’. This will bring up the stock price of Coca Cola, and below you will see the P/E ratio at the current time.
If you follow Preston Pysh’s series earlier, you want the P/E ratio as low as possible. Me personally? On Buffett and Graham’s wise words, I try to avoid buying stocks that have a P/E of above 25, and absolutely run for the hills if it’s over 35. But higher P/E doesn’t always indicate it’s riskier — so make sure you read this.
Hopefully you are seeing a pattern — this is just another guide that should be used as a warning rather than an absolute decision maker. It’s a piece of the puzzle you have to understand then put together based on all that other good research.
Please do your research and read the footnotes properly before you decide if a stock is at a reasonable price.
Part 4: So when should I sell?
First I would like to tell you why you shouldn’t always sell when the price goes up. It comes down to not being greedy. I learned the hard way when I sold a significant amount of shares in a little electric car company back in 2013 when the price reached the mid $40’s. Thinking I was being clever and bailing out with a profit — It just so happens that company was ran by a fellow you may have heard of, Elon Musk, and my stake in his company Tesla Motors would have been worth much more than it was when I sold it.
Yes … I cry myself to sleep every night, so lets use my mistake to make a point.
“So I thought you said you only buy for the long run?” Well, I suppose I should say we only learn by experimenting, or that I knew the stock was going to crash… but those aren’t true. I was being a hypocrite — worse I was being an impatient greedy sod taking a gamble.
So why am I complaining if I made a profit?
I only allocated a small portion of my portfolio size to Elon Musk, and while it did pay off (100% return in a very short time) I sold way too early, and missed out on significantly more profit down the line.
The moral is simple: You need to let your winners run.
What I should have done is set a stop-loss on my portfolio (which basically means your broker will automatically sell if the price of the stock drops by a % that you set manually) and waited just a few more years. One day Tesla may pay have paid an attractive dividend and be worth 100 times what it is now, and I will regret the short term profit even further.
It was also a true gamble, because Tesla didn’t fit many of my investment rules. I am lucky it went green and not red. It was pretty good learning experience — gambling recklessly can reap rewards, but isn’t for me.
You should sell when the business you are invested is performing poorly (and will likely continue to do so).
Coca cola, one of Buffett’s many great early investments, survived and prospered through an entire century including two world wars, the great depression, countless market crashes and corrections, countless recessions and so on.
“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.” — Warren Buffett
While open to interpretation as quotes are, what I believe Buffett is getting at here is that if he trusts in his own research so confidently, he rarely needs to sell stocks in good company. If you understand the company you own well enough to see problems and warning signs coming before ship sinks — you have a much better chance to avoid drowning with the sheep when it sinks.
If you sell every time the market wobbles (up or down), you are eating away at your long term success because,the second you sell, your compounding interest ends. The pot stops growing, and you are stuck with that loss or profit. However, like the Buffett quote abouve, if the company is going broke and the stock price is tumbling because of problems that good management can’t fix, it’s time to jump ship.
The beauty of buying truly Good companies at Cheap prices is that they tend to last and grow for decades or even centuries like CoCa Cola or Berkshire Hathaway. If you invested in $1,000 of shares in Berkshire Hathaway during the late 1960s or early 1970’s when Buffett was really getting into his stride, you would have had gains in the region of $10m by 2016. In a letter to shareholders back in 1996, Buffett and Munger wrote:
“Do not think of yourself as merely owning a piece of paper whose price wiggles around daily and that is a candidate for sale when some economic or political event makes you nervous. … Instead visualise yourself as a part owner of a business that you expect to stay with indefinitely, much as you might if you owned a farm or apartment house in partnership with members of your family.”
Buffett sells very, very rarely. He is practically the definition of long-term investor that would rather hold forever than sell as long as a business maintains its competitive advantage.
Even Buffett gets it wrong occasionally. When you make a mistake, cut your losses — but if you don’t learn from that mistake, you are doomed to repeat it over and over.
If you are following other peoples stock picks blindly, you shouldn’t be investing. I love Buffett’s approach, but I don’t blindly follow his portfolio shuffles because I am not Warren Buffett, I never will be, and I don’t understand all the companies he buys. In fact, he’s accumulated more wealth in his 80+ years than almost any other individual who has ever lived on earth, so good luck. This is also pretty crazy.
If you have read this far and either my writing has put you off, or it’s so bad that I’ve confused you further… fear not. Warren has some advice for you too… just buy an index fund. (Such as the FTSE 100 or the S&P 500) Set dividends to reinvest automatically with your broker, keep reinvesting the dividends and adding to your holdings over the years in the same manner.
Index funds (what is an index fund? by Investopedia) generally return less than a tailored individual stock portfolio does year on year, but hey, you don’t have to worry quite as much about it, nor do you need to do much research — they have a broad market exposure and low operating expenses. (Over the past 20 years the FTSE 100 index has risen at about 5.4% per year, excluding fees, dividends and inflation — During this period, the market has seen the dotcom bubble and the financial crisis: two events that have sent the FTSE 100 surging to a high of nearly 7,000 and crashing to a low of around 3,000).
Final thoughts
(and further reading to get your foot in the door.)
You may be wondering what stocks apply to all the above information, and perhaps what Buffett is buying or selling beyond the couple that I mentionned…. but I am not going to tell you here, because that is exactly what you should not be doing!
I use Halifax Sharedealing online to buy my stocks and manage my portfolio. You can use any broker you like, see here for others. You will also need to learn about taxes and legalities, so I recommend a chat with an accountant first.
I hope this has encouraged you to learn more about jumping in. Trying to emulate billionaire investors successfully is difficult, but I am still trying, and I hopefully nudged you to want to give it a go after reading this wall of text.
Preston Pysh
Fantastic video series on investing which covers Buffett’s methods extensively
https://www.youtube.com/watch?v=KfDB9e_cO4k&list=PLECECA66C0CE68B1E
The Investopedia. Great information and breakdowns of terminology http://www.investopedia.com/university/stocks/
Great speeches from Buffett and Munger (youtube is filled with these, just search for them)
https://www.youtube.com/watch?v=2MHIcabnjrA
https://www.youtube.com/watch?v=ldPh0_zEykU
https://www.youtube.com/watch?v=3WkpQ4PpId4
https://www.youtube.com/watch?v=rLXtRjfVwcw
“We study billionaires” A great podcast
https://www.theinvestorspodcast.com/
Recommended books, and sources of many of the quotes I used:
http://amzn.to/2gyNx2u
