Core Principles
for Investing in Stocks
By Manuel Maurício
April 08, 2021
The problem with investing in stocks is that it takes time for you to know if the choices you’re making are the right ones.
Wouldn’t it be good to know beforehand if you’re doing the right thing?
Although this isn’t possible, there are some well-tested principles that can help you avoid some pitfalls and get better returns on your money:
Learn how to read financial statements
There’s no way around this. I’m not talking about “reading” charts, or focusing on the price of a stock, or on any macro events. I’m talking about understanding the business you’re looking at. And businesses speak their own language.
You’ll never understand a business without understanding basic accounting principles and how to read the 3 financial statements. Luckily for us investors, we don’t have to understand a company’s financials as if we were accountants.
Because I’ve struggled with this myself (I was an architect who knew nothing about accounting or finance), I’ve written a basic guide on how to read financials statements. Be sure to check it out.
Look for simple businesses with great management
This should go without saying, right? Maybe not.
I can’t begin to tell you how many people I’ve met who came to me with stock ideas without understanding the business behind it. Be sure you’re investing in something that you understand.
Ask yourself “Do I really understand this business?”. And then try to explain it to a 3 year old. If you can’t explain it in a sentence or two, forget about it.
Also, be sure to Google the names of the managers to check if they’ve been involved in scams or any other problems in the past.
Diversify over a few stocks
This is very important. Believe me, I’ve been there and you can learn from my mistakes.
There are some great investors that will tell you that the best way to become rich is by concentrating your investments on those few great opportunities. They’re right.
But that’s only half truth. First of all, concentrating your investment in just a handful of stocks is also the best way to lose all your money. And when it comes to investing, you don’t get points for being the boldest guy in the room. Safe and steady wins the game.
Then there’s another important argument against concentration. When you’re just starting to invest, you don’t know which will become the best investments. You’re still testing the waters. And as Warren Buffett famously said, “don’t test the depth of a river with both feet”.
Be sure to diversify over a fair number of stocks. How much is hard to say, it depends on how many companies you can understand and how many good ideas you can find. As a rule of thumb never put more than 5% of your money on a single stock.
Have an exit plan
Something that very few people will tell you is that buying a stock is way easier than selling it. If you don’t agree with me right now, you will.
When you buy a stock, write down the 3 reasons that would make you sell it. These can be stuff like “the management did the opposite of what they said they would do”, or “the new product was a complete flop”, or even “I’ve made a mistake when I was doing my research”. This last one is very important. Being humble enough to acknowledge that you’ve made a mistake is a super-power. I’ve written about it HERE.
Whatever the reason, write it down BEFORE hitting that BUY button. Believe me, you’ll become a much better investor if you do this.
Don't panic
If you look at the best investors in the world, you’ll see that they never panic. In fact, when everyone else is panicking, they’re acting very rationally. That’s the Budha level of investing. And you can only reach it by training hard all the other aspects of investing, especially the aspects I’ve laid out on this article.
Remember:
- If you don’t have a basic understanding of the financials of your companies, you won’t know if you should be selling when everybody’s selling or if you should be buying more of it instead.
- If you don’t understand the business, you won’t have the conviction to hold when sh*t hits the fan.
- If you aren’t diversified enough, you won’t keep your head cool to make rational decisions.
- If you have never pictured that ugly scenario in your mind and you don’t have a plan, you’ll be panicking at the worst possible moment.
Conclusion
Apart from the one about reading financial statements, these are all soft skills, right? Right. But I can’t begin to tell you how important they are.
When you talk to a seasoned investor, even the greatest of all time, you’ll see that they aren’t worried about what’s the right P/E for a given stock. They’re not worried if the stock price has gone up or down over the past few days.
They’re worried about the nuanced stuff, usually their behavior. That’s how you master investing, by mastering both the hard skills and the soft skills.
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