Though it is true that there are no set rules for good stocks to invest in, there are some rules that are uncontestable and that are adhered to by most successful long-term investors. Let us review some general principles to help investors understand how they can be successful long-term investors.
Get Rid of Losers (Don’t try to “get back to even”) –
Many investors are accustomed to selling those shares that are doing well in order to lock in some profit and holding on to the shares that have experienced a fall in their prices. With these losers, they want to “get back to even.”
This is foolish. Your criteria for deciding whether to sell a stock or to continue to hold onto it should be whether it is currently trading above or below its true value. If, after purchasing a stock, you discover that it is not what you thought and you suddenly realize you own a stock that is selling above its true value, then sell it before you lose even more.
It is impossible to invest and not make some mistakes. When this occurs, it is foolish to not acknowledge these mistakes, learn from them, and move on.
The market tends to go up, and even underperforming stocks can make a profit. Therefore it is possible to “get back to even.” But this does not change the fact that hanging on to an overpriced mistake just because you want to “get back to even” will only hurt your relative profits in the end.
Do not Accept a Hot Tip–
Don’t accept a “hot tip” from anybody, even from us. In fact, we never claim to have some critical information about a company’s future that cannot be found or calculated by studying the financial statements. Be skeptical and leery of anyone who does. Hot tips are either bogus (and as dangerous as snake oil), or they are real and illegal.
The greatest profits in stock investing come from developing a systematic method of identifying mispriced stocks and then employing that method diligently and patiently. You cannot count on a continuous stream of “hot tips” to beat the market unless you are doing something serious illegal.
Furthermore, hot tips are unnecessary. Beating the market is very possible by studying the easily accessible public information. If you doubt this, search for the best stock research sites on Google. Those few that display their complete performance as quickly and as prominently on their websites as possible are usually the excellent research firms that truly can beat the market and honestly help their subscribers to do the same. Start with the best stock research sites.
Ignore Price Changes–
We said in the first point that if a stock has gone down, you should not be reluctant to sell it just because you want to get back to even. That is still true. However, you shouldn’t be reluctant to hold onto it either. You should not sell a stock just because it has gone down in price.
Sometimes, after a stock is pummeled, it is selling at a discount to its underlying true value (even if it’s true value is not as great as was first presumed).
The bigger point here is this. Do not make your decisions based on the change in the stock price. Focus on the fundamentals, and try (as much as possible) to ignore the price changes and price volatility. Use any significant change in price only as a catalyst to reconsider the underlying fundamentals.
Do Not Overemphasize the P/E Ratio–
The P/E ratio is one of the most powerful and useful tools in stock analysis. A similar statement could be said about most of the other price multiples. Still, we feel most investors give the P/E ratio too much weight.
It is important to buy low-priced companies. But there are thousands of companies to choose from. It is possible to find low-priced companies without sacrificing quality too much.
There dozens of other variables available indicative of a firm’s quality. You should not let any of them go to waste. You should study them all and try to find companies that grade out well on as many as possible.
Favor the Top Dividend Paying Stocks-
Dividend-paying firms are generally low-risk firms, and therefore it is easy to see why they are favored by risk-averse investors. But many people do not realize that the dividend is one of the most powerful analytical tools available. Even investors who do not consider themselves risk-averse should have at least a slight bias for the top dividend-paying stocks. And long-term investors, who want companies that will excel over the long run, should have a definite bias in favor of the top dividend-paying stocks.