Understanding Investing

 | May 22, 2013 | 3:00 PM EDT
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Just about everyone interested in investing in stocks has the intellectual capacity to be a successful investor. The rules required for successful investing don't require above average intelligence or mathematical ability. Where many fail is in the application of those tenets.

I define success in investing as producing a long-term investment track record that provides a satisfactory risk-adjusted return in excess of the current inflation rate. Put another way, it is a return that beats the market by 2 points or more per annum. Ultimately, however, successful investing is that which in the end sets you up for having more winning bets than losing ones.

Listed below are some of the most important conceptual tenets that I believe define and create a successful investment program. Understanding them is the first step. If you can truly apply them, odds are quite strong that your investment performance will be very satisfactory.

  • Understand that the shares of stock you own represent an underlying business. You hold the stock but your money is invested in a business. The value of any business is not determined by the daily price movements of its stock price, but by the underlying performance of the business. Businesses require years to grow and create value while stock prices move daily. In the short run, the movement of a stock price is virtually meaningless to the underlying business.
  • Stock price volatility comes into play in creating opportunities to buy or sell at attractive prices. Price is single most important determinant in future investment return. At a given price, a business is either undervalued, fairly valued, or overvalued. Anyone who bought Apple (AAPl), an excellent business by many qualifications, at $700 per share is doing far worse today than the person who bought Hewlett Packard (HPQ), at the moment a mediocre business, at $12. Don't be too obsessed with quality. Quality assets bought at the wrong price can be terrible investments, whereas poor assets bought at bargain prices can be excellent investments.
  • To generate positive investment returns you simply cannot have big losers. Loss avoidance is paramount to long-term investment success. Notice I said "avoidance" and not "elimination." Of course, you will lose money over the course of a long investment horizon. But you have to eliminate the blowups. To do that, all investors should possess the conviction to quickly dismiss businesses that can blow up and stay away from those that have too much debt, unproven business models, a challenging end market or no business advantage. Often, investors will experience poor investment results not because they can't pick winning investments, but because the winners are negated by avoidable losses.

Warren Buffett said it best when he remarked that investing is easy, but not simple to implement. Application is the key. 

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