How does it feel for you when you invest? Do you get nervous when stocks fall? Do you get frustrated when stocks rise without having invested?
When I invest, I pay close attention to my emotions.
Firstly, I check if I’m influenced by fear or greed.
If that’s the case, I do nothing. Neither buy nor sell.
It Should Feel Like a Safe Investment
Secondly, I check if it feels “safe.”
I want to invest based on a sense of robustness, security, and certainty. Of course – who wouldn’t want that?
I’m here to tell you that it’s possible.
This doesn’t mean that the price won’t fall after I’ve invested. But if it does, I buy more shares.
How do I achieve that sense of safety and security?
Well, I’m not an oracle. To reach that feeling, I go through a checklist and answer a lot of questions.
I do the research, and then I check in with my inner barometer.
Here are some of the things I look at:
1. The Company’s Products
Do I believe in what the company sells?
Is it a good product or service? Do I personally like it? Do I use it? Or do I know someone who uses it?
Will there be more of the same in the future?
Are they good at innovating with the product and coming up with more products?
2. The Company’s Leadership
Who is the management?
Do I trust them? What do they stand for? What are their values?
I especially like owner-led companies or companies where the CEO owns shares and thinks like an entrepreneur.
Here, I carefully examine the management’s letters to shareholders and read them chronologically. I look at what they have promised in the past and whether they have succeeded.
If they haven’t succeeded, are they honest in explaining why? Or do they sweep it under the rug?
I also look at whether they have conducted share buybacks and at what price. It should be at a reasonable price. If the management just buys back shares at unreasonably high stock prices, they dilute the value – perhaps in the hope of maintaining or plumping up the share price – but it’s not a viable strategy.
I also look at how the management is compensated. Are the bonuses fair? Is there a sound incentive structure?
Finally, I examine the composition of the management. Are there diverse competencies and types of people? I’m not interested in investing in companies where the top management and the board consist of only one specific type (e.g., only men).
3. Growth and Development
How do the numbers look?
Is revenue growing consistently? What about profit?
And the equity? Is it also growing at a steady pace?
I prefer to invest in companies with high growth on all three fronts.
Some people talk about growth investing versus value investing. That’s nonsense.
Without growth, it’s difficult to make a good investment. As a value investor you should focus on investing in growth companies – at reasonable entry prices.
When I quickly skim their numbers, I also check that they don’t have too much debt (they should be able to pay off their long-term debt within three years).
4. Competitive Advantages
Can the company protect itself against threats from competitors? How do they retain customers?
Here, I go through a range of possible competitive advantages. I prefer the company to have at least two, preferably three of them.
Competitive advantages can be, for example:
- Size (economies of scale)
- High entry barriers in the industry
- Network effect in the use of their products
- Switching costs
- Special knowledge, data, or secrets
- Power position regarding suppliers or distribution
Most students who come to the Value Investor Academy easily overlook this point.
Competitive advantages are something you need to train yourself to spot.
5. Peer Comparison
Lastly, I compare them to their competitors.
Who are the others out there?
How do their growth, profitability, and equity development look?
Is our candidate a market leader? Is it growing faster than the others and hence eating up market shares?
Or are there others out there who are even better candidates in the industry?
6. Value vs. Price
I calculate the company’s intrinsic value and ensure it’s higher than the stock price. In other words, you get more value for your money than what you pay.
If you buy stocks when the stock price and market value are above the intrinsic value of the company, there’s a high risk of losing money in the long run – even if the company is a wonderful company.
It may sound complicated to calculate a company’s value, but it’s not. It can be done on the back of a napkin (you can learn to do it in my e-book Free Yourself).
I also check that the stock price is not at its all-time high. If it is, it’s probably not a good time to invest – at the very least, it’s a good time to reassess.
The Feeling of Security Comes From Research
The sense of investing in something safe comes from knowledge and research.
Clearly, nothing is certain in this world. Everything you do will come with a degree of uncertainty.
Even when you cross the street, you can’t be 100% sure that you’ll safely make it to the other side… but you can feel safe while you do it.
If you know the area and the traffic rules, you can cross the street without getting a feeling of anxiety at the sound of the smallest scooter.
In the short term, we cannot be sure how the stock price will develop. But in the long run, we can have quite a lot of certainty if we know the rules of the game and understand what a “wonderful” company is.
One thing is certain in the stock market. Stock prices go up and down, and down and up – all the time. They’re like goldfish in a bowl.
That’s part of the game.
Security comes from doing solid research and understanding the mechanisms of the stock market.
Just like you feel more secure crossing the road when it’s one you’re familiar with and you know the traffic rules.
So get to know the traffic rules in my e-book Free Yourself here.