How to Think Like an Investor
Investing is, by definition, a long-term act. When you invest in a stock, you’re buying a piece of a business. When you invest in an index fund, you’re investing in a collection of businesses. You’re literally becoming a part owner of those businesses!
This is why investing isn’t about merely trying to make a quick buck or “buy low and sell high.” To be an investor means you are thinking about the future and the direction of the world. It means you are paying attention to the world around you. As an investor, I think about out where the world is going over the next five, 10, 15, 20 years and beyond and invest in the companies that I believe are likely to push the world in that direction.
Even if you’re not investing in individual stocks just yet or decide to only invest in index funds (which are relatively safe since you’re investing in a basket of hundreds of companies), it’s worth taking some time to look at the world through the eyes of an investor.
Thinking Like an Investor
These are the first questions I ask when I’m researching a company as a potential investment.
1. How does this company make money?
You’d be surprised how many people struggle to answer this when they’re researching a company. Start with the basics.
2. Can you illustrate what this company does — and how it makes money — with a crayon?
In other words, can you explain what the company does in a way that an 8 year old could understand? If not, you probably don’t understand the company well enough to justify investing your hard-earned dollars in it.
3. Will this company be doing the same thing five years from now, or will it look different?
This gives you an idea of the sort of risk — and opportunity — that comes with any given company. I think it’s a pretty safe bet that Clorox will be selling the same products five years from now. Facebook, on the other hand, will probably look a lot different five years from now than it does today. (Five years ago there were legitimate concerns whether Facebook could be successful on mobile devices. A lot can change in five years.)
Companies like Facebook are likely to grow faster than Clorox, but they’re also riskier since they have to continually innovate and reinvent themselves while Clorox just keeps selling the same ol’ bleach year after year.
4. How likely is this company to be making more money five years from now than it does today?
If you don’t think it’s likely for a company to make more money five years from now, then investing in it today isn’t a great idea.
5. Will this company be more relevant five years from now than it is today?
I want to invest in companies that are in a position to become increasingly relevant in the coming years.
6. What does this company do or have that its current competitors can’t replicate?
Imagine that a company is a castle. Then think about the moat around that castle. How hard is it for a competitor to cross that moat and damage the castle? Facebook’s moat, for instance, could be its large and growing base of billions of users (not the easiest thing for a competitor to attain) and/or having a young and proven leader like Mark Zuckerberg.
7. If you snapped your fingers and this company disappeared, would the world notice or care? Would the company be missed by you or your friends?
Imagine the chaos that would ensue if Amazon disappeared overnight. The companies who become ingrained in our culture and daily lives are great places to start looking for investing ideas.
8. If this company succeeds, will the world be a better place?
Since you become a part owner when you invest in a company, become an owner of companies that you’re proud of and want to succeed over the long term. Invest in companies that make you proud to be an owner.
9. Do you trust the leadership of the company? Do you agree with their vision for the company?
Make sure you’re comfortable with the captain at the helm of the ship and the direction that the ship’s headed.
The Bottom Line
These are questions to start thinking like an investor. My favorite part about investing is looking at the world around me, thinking about which companies are going to change the world for the better in the years ahead, and being able to become an owner of those companies through the stock market.
Not only is this a lot of fun and sure to open your eyes to a new perspective of the world, history has shown that investing in the stock market also happens to be the most effective way to generate long-term investment returns. It’s a win-win.
Pay attention to the world around you. Think about where the world is going. Think like an investor.