Five golden nuggets for investors

If you sincerely follow these, nobody can stop you from creating wealth in the long run

Illustration: Uttam Ghosh/Rediff.com

Everyone has different goals and varied time frames for achieving them. A retirement goal would be decades away while a "saving for my wedding" goal could be just 24 months down the road.

Two individuals with similar goals -- such as saving for a child's education, could also have completely different time frames. However, certain principles stay the same.

Equity investors must note this.

1. Stocks work over the long term

In the short term, stocks tend to be volatile, bouncing around every which way on the back of the market's knee-jerk reactions to news as it hits. December 18 was a case in point as everyone was watching the results of the Gujarat elections.

Trying to predict the market's short-term movements is not only impossible, it's maddening. It is helpful to remember what Benjamin Graham said: In the short run, the market is like a voting machine -- tallying up which firms are popular and unpopular.

But in the long run, the market is like a weighing machine -- assessing the substance of a company.

Yet all too many investors are still focused on the popularity contests that happen every day, and then grow frustrated as the stocks of their companies -- which may have sound and growing businesses -- do not move.

Be patient, and keep your focus on a company's fundamental performance.

In time, the market will recognise and properly value the cash flows and earnings that the businesses produce.

2. Behave like an owner

Stocks are not merely things to be traded, they represent ownership interests in companies. If you are buying businesses, it makes sense to act like a business owner.

This means reading and analysing financial statements on a regular basis, weighing the competitive strengths of businesses, making predictions about future trends, as well as having conviction and not acting impulsively.

There are many media outlets competing for investors' attention, and most of them centre on presenting and justifying daily price movements of various markets.

The price changes rarely represent any real change in value. Rather, they merely represent volatility, which is inherent to any open market.

Tuning out this noise will not only give you more time, it will help you focus on what's important to your investing success -- the performance of the companies you own.

3. Don't be stubborn

In investing, the line between being patient and being stubborn is thin, unfortunately.

Patience comes from watching companies rather than stock prices, and letting your investment theses play out. If a stock you recently bought has fallen, but nothing has changed with the company, patience will likely pay off.

However, if you find yourself constantly discounting bad news or downplaying the importance of deteriorating financials, you might be crossing that fine line into stubborn territory.

Being stubborn in investing can be expensive.

Always ask yourself, "What is this business worth now? If I didn't already own it, would I buy it today?"

Honestly and correctly answering these questions will not only help you be patient when patience is needed, but it will also greatly help you with your selling decisions.

Any valuation model you may create for a company is only as good as the assumptions about the future that are put into it.

If the output of a model does not make sense, then it's worthwhile to double-check your projections and calculations.

Use DCF valuation models (or any other valuation models) as guides, not oracles.

4. Be careful of snakes

You can be a great racecar driver, but if your car only has half the horsepower as the rest of the field, you are not going to win.

Likewise, the best skipper in the world will not be able to effectively guide a ship across the ocean if the hull has a hole and the rudder is broken.

Management matters. While that can (for better or for worse) change quickly, the economics of a business are usually much more static.

Given the choice between a wide-moat, cash-cow business with mediocre management and a no-moat, terrible-return businesses with bright management, take the former.

Though the economics of a business is key, in no way must investors undermine the stewards of a company's capital.

Even wide-moat businesses can be poor investments if snakes are in control. If you find a company that has management practices or compensation that makes your stomach turn, watch out.

When weighing management, it is helpful to remember the parable of the snake. Late one winter evening, a man came across a snake on the path.

The snake asked, "Will you please help me, sir? I am cold, hungry and will surely die if left alone."

The man replied, "But you are a snake, and you will surely bite me!"

The snake replied, "Please, I am desperate, and I promise not to bite you."

So the man thought about it, and decided to take the snake home. The man warmed the snake up by the fire and prepared some food for the snake.

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After they enjoyed a meal together, the snake suddenly bit the man.

The man asked, "Why did you bite me? I saved your life and showed you much generosity!"

The snake simply replied, "You knew I was a snake when you picked me up."

5. Pay wisely for quality

If you focus your attention on companies that have wide economic moats, you will find firms that are virtually certain to have higher earnings five or 10 years from now.

You want to make sure that you focus your attention on companies that increase the intrinsic value of their shares over time. These afford you the luxury of being patient and holding for a long time. Otherwise, you are just playing a game of chicken with the stock market.

Finally, the difference between a great company and a great investment is the price you pay.

There were many fantastic businesses around in 2000, but very few of them were attractively priced at the time.

Finding great companies is only half the equation in picking stocks; figuring out an appropriate price to pay is just as important to your investment success.

Always have a margin of safety built in to any stock purchase you may make -- you will be partially protected if your projections about the future don't exactly pan out the way you expected.

Having a margin of safety is a recurring theme among several great investors. This is no accident; margin of safety really is that important.