It’s relatively easy to get down to the financial metrics for every investment, analyze the company, and know what to expect.
The difficult part isn’t finding good investments, it’s more about whether our mindset is ready to take advantage of the opportunities the market offers.
In today’s article, I’ve summarized the investing rules that have helped me in achieving market-beating returns over my 15-year investing career.
Look At Long Term Earnings & Buy When The Earnings Yield Is Above 12.5%
Analyze earnings and start buying when the average earnings return is over 12.5% in the long term, thus the long-term average PE ratio is below 8.
Many stocks experience temporary turbulence, or there’s negativism surrounding the sector, or the growth hasn’t yet been recognized. Buying at such a high earnings yield allows your investment to not have to depend on what goes on in the market, but only on the fundamentals.
Sooner or later, the quality earnings will be recognized. The more visibility you have into future risks through increased research, the better.
Be Satisfied With Finding 10 Good Stocks To Watch In A Year & Be Happy If You Buy One
If you invest 10% of your portfolio in a stock and are ready to increase the exposure to 20% if all hell breaks loose and hold it for two years, the returns will be double on the 10% and quadruple on the 20% exposure.
I like that one good investment per year is enough to have amazing returns. The main factor is DISCIPLINE as you have to be able to do nothing until you find an investment that has no risk and huge upside.
Imagine the Worst-Case Scenario & Reverse Engineer It To Understand How You’d Go About Dealing With It
The worst-case scenario happens all the time in the stock market, so think about how you would go about handling it and how you would execute.
When investing, always be thinking first about what can go wrong and only then of what can go right. Thinking first about the risks is another thing that’s unnatural for us to do, but it sure prevents many investing mistakes.
When all that can go wrong is already priced-in to the stock, then there’s a margin of safety in that purchase.
Always Keep A Cash Cushion
No one knows where the stock market may go in the short term, and therefore it’s always prudent to have a cash cushion that allows you to purchase more if a stock price declines.
How much can a stock decline? In my career, I’ve bought stocks with price to earnings ratios of 2.5. When a good business has a PE ratio of 5, you might thin it’s impossible for it to go any lower, but you might be surprised how often it does go lower.
Always Invest With A Large Margin Of Safety – 50% Discount To Fair Value
Always invest when the margin of safety is huge and coming from the cash per share, liquidation value, takeover price potential, brand power, number of users, or positive sector trends, short term and long term. This allows you to avoid permanent capital losses as they will destroy long term returns.
Sell When A Stock Hits Your Target & Rebalance The Risks Accordingly
Don’t become infatuated with a stock. When the price is much higher than what the fundamentals say and there are better investing options, it’s prudent to rebalance away from that position.
Always Buy In Stages
J.P. Morgan once said that the only everlasting truth about the stock market is that “It will be volatile.” Therefore, you should expect anything and buy in stages.
Buy so much at a 50% discount to fair value, so much at 60%, etc. Be sure to adjust your cash cushion to what you want from your investing strategy.
Keep A Macro Hedge That Could Become A White Swan
There’s so much market distortion coming from central bank activity that could lead to incredible financial turmoil if central banks lose the control they have over financial markets.
The Bank of Japan owns more than 60% of all Japanese ETFs. This shows how current financial markets have nothing to do with natural supply and demand forces determining prices. Therefore, a gold related investment could really become a jack-pot investment if all hell breaks lose. A portfolio allocation of five to 10 percent should do no harm to long term returns, but could prove extremely wise.
Don’t Ever Trust The Management – Do Your Own Due Diligence & Ask Yourself What Can Go Wrong
Managements are paid to be optimistic about the business. However, this usually leads to terrible situations where the management doesn’t deliver.
It is extremely important to confirm any investment thesis not from what the management is saying, but from facts that come from independent research.
Know Your Financial Goals & You Will Get Exactly What You Expect
As with anything in life, it’s crucial to have clear and precise investing goals as you’ll probably get what you ask for.
Those who ask for capital protection will usually get just that, those who ask for single digit returns that are better than their savings will also get just that, and those who are willing to put in the effort to get yearly returns of 20% or more will get exactly what they’ve focused on.
I hope you’ve enjoyed my rules to succeeding at investing. Keep reading Investiv Daily as I’m always analyzing investing opportunities with the rules I’ve described here in mind.