To Be a Good Investor, You Must Start With Lesson Number 1

by Derek Clark

This is a guest post by Mariusz Skonieczny. He is the founder and president of Classic Value Investors, LLC, an investment management company. He is also the author of Why Are We So Clueless about the Stock Market? Learn how to invest your money, how to pick stocks, and how to make money in the stock market.

If you are a beginning investor, it can be very confusing to listen to others who give you advice on how to invest your hard-earned money. The best thing that you can do is ignore most of the advice and educate yourself following the strategies of investors who successfully built wealth over long periods of time, not just over the last few days, months, or quarters. I would suggest reading lots of books on the subject of value investing.

The major theme that you will get from reading these books is that in order to be a successful investor, you must think that when you buy stocks, you are investing in businesses because this is exactly what stocks represent. When companies are started, they usually are funded with some type of private or venture capital money. When a company becomes big enough, its management might turn to the public markets to raise money to pay off the original financial backers and to grow the business going forward. When that happens, the company issues shares to the public through a process called the Initial Public Offering, and these shares are assigned ticker symbols such as DVR or MORN.

At this point, they start trading on the exchanges such as the NASDAQ or New York Stock Exchange. These exchanges allow stock owners to buy and sell their ownership interests in companies. While it can be very cumbersome to buy and sell private businesses, shares of publicly traded companies can trade hands with a click of mouse. This liquidity can be advantageous for investors because it allows quick access to cash, but I believe that it actually lures investors into becoming gamblers or speculators.

For example, do you know anyone who has a successful business? You probably do. How many times do you see this person selling his or her business during the course of a year? He or she probably holds on to the business for years, if not forever, reaping the benefits of business ownership. However, because public markets allow investors to buy and sell within seconds, this allows them to become flaky investors who forget about the underlying business and, instead, focus solely on the stock price. As a result, they are willing to abandon their ownership whenever bad news about the company is released. A private owner would never sell a business simply because the Fed changed interest rates or China’s GDP slowed down.

If you truly want to experience success in investing, you must realize that when you buy stocks, you become a partial owner, or a salient partner in the businesses that these stocks represent. But that’s not everything. Just because you realize that a Lexus is a car doesn’t mean that you should be willing to pay any price for it. Depending on the model and year, you would not pay more than you think it is worth. Businesses are no different – they have values. It is safe to say that Business A is worth more than Business B, if Business A generates more money than Business B.

So it would be logical to assume that it is not the best strategy to overpay for businesses because when it is time to sell, for whatever reason, it would be hard to find another fool that would be willing to overpay you for your business. While this may seem logical to you, this is exactly the opposite of how the majority of investors invest. They get excited when prices go up and depressed when prices go down. So they are happy and more willing to buy businesses when they become expensive, and they are sad when these same businesses become cheaper. To me, this doesn’t make any sense, but this is the world of investing.

The recipe for successful investing is simple: treat stocks as businesses, buy them with the intentions of becoming an owner, pay only the price that makes sense, and wait for your wealth to grow. That’s it. It is that simple, but for some, it is too simple. The investment industry cannot possibly follow this strategy because how else would most investment professionals justify charging you insanely high fees in relation to its terrible investment performance?

{ 1 comment }

Bern June 8, 2010 at 6:25 am

Value investing is a great concept.

However, should it be done with stocks? Take the idea above that you become a partial owner when you buy the stock. Keep in mind, you have no control over how the stock performs. You have no control over the market and how it affects the stock. And, you have no control over the company’s operations and how they drive the stock price up or down.

Just a thought…

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