Sabtu, 12 Januari 2013

Two Important Lessons in Investing

Lesson One: Invest From A Business Perspective

One of the most important lessons Buffet learnt was to invest from a business perspective. Most people treat stocks like lottery tickets. Buying and selling based on predictions of whether the price will go up or down in the short term. 

Because stock prices go up and down randomly and erratically based on world events, there is no way anyone can consistently beat the market by attempting to predict its movements. Many of these punters know every little about the business operations behind the stocks they own. 

Warren learnt that buying a stock meant becoming a part-owner of an ongoing business. He knew that the only way to consistently make money was to identify very good businesses run by a strong management team. 

Good businesses would over time generate higher and higher profits. Increasing profits will increase the value of a company and hence its share price. 

By honing his expertise in sniffing out companies that had the potential to generate huge amounts of earnings growth over time, he was confident that the stocks he held onto would increase significantly in price over time. 

Lesson Two: The Market is Irrational, Take Advantage of It

While most financial experts teach that the market is rational and efficient (stock prices reflect the true value of a company), Benjamin Graham taught Buffett that stock market prices were determined by demand & supply, which in turn are irrationally driven by fear and greed. As a result, a stock's price did not
always reflect the true value of a company. 

In times of mass investor optimism & greed, buyers rush in and push a stock's price way above its value. In times of fear and panic (i.e. news of a recession) investors sell their shares, causing a stock's price to fall way below its value.

The Market tends to overvalue a company's stock when there is good news and under-value a company's stock when there is bad news. 

Benjamin Graham developed a systematic way to determine a stock's true value (known as its intrinsic value) and taught that by buying a stock when it was undervalued, the investor could make a huge profit when the market eventually overvalued the stock. 

Philip Fisher added another dimension to investing by developing a way to not only find undervalued companies, but to find companies that had the potential to also significantly grow in their earnings and hence increase their stock value even higher. 

Any investor no matter which level he is at should learn about and make use of the lessons covered here.

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