It is often said that no one can beat the market, and yet individual investors do it all of the time. No it is not the guy who is always talking about the market and his trades. You know, the guy who is always checking his blackberry for stock quotes and telling about his victories and war stories. It is the one who quietly builds up large positions in companies and holds onto them as they grow.
Growing wealthy through stock picking is very similar to growing wealthy by starting your own company. When starting a company one chooses an idea, finds some starting money, and then works hard to make the business grow. Often substantially all of one’s money is in the business. With a lot of hard work, some good management of finances and payrolls, a good idea and a bit of luck, one can become wealthy through one’s business.
Growing wealthy through stock ownership is a similar process, except the hard work is eliminated – traded, actually, for loss of control over the company. Luckily, however, you can take advantage of professional managers with graduate degrees from ivy league universities – the type of management team you would never be able to hire on your own. The trick is to think like you are becoming a partner in a business rather than trading stocks.
When one trades stocks one is generally concerned with price movements. If the stock is moving up in price, one will hold on, perhaps taking a bit of profit by selling a few shares on the way up. When the stock appears to be peaking, one will sell to lock in the profit before the price retreats. Often this results in one selling out of profitable positions too soon or even buying stocks near peaks and selling them after sharp sell-offs. This is an exciting way to invest, but generally it will result in little profit. If one is lucky one will tie the market. In general, however, the additional tax and trading cost burden of moving in-and-out of the markets will result in substantially lower returns.
When one buys like a partner, one is taking a long-term stake in the company. The price really doesn’t matter much, as long as it is not too great when buying in to make the profit potential unappealing. One expects the price of the stock – the sale price of the business – to fluctuate with time. One does not care so long as the business is growing and prospects for it becoming more valuable in the future remain bright.
One also looks at the company differently. Rather than charting price movements, one looks at the business. How profitable is the business line? Who are the competitors? Does the company have a unique market advantage? How much room remains for growth? How talented is the management team and how invested are they in the company’s success? If held for a long time, what will be the return (dividends) of the company? Is there a better place to put one’s money? Is the debt level manageable (no debt often points to a well-run company that has a lot of ability to take advantage of opportunities).
Investing in businesses, one would also tend to concentrate holdings more than one would when trading stocks. Advisors often recommend holding many, many different companies for diversification, which protects against volatility in individual stocks. If one were buying into businesses, however, one wouldn’t put money into every place on the block. One would be very selective and just pick a few businesses (more than just one because things do happen).
The added level of screening helps to guard against picking the bad companies, allowing one to concentrate more than is generally recommended (although one should never put more into an individual stock than one is willing to lose). As one does well and the value of one’s portfolio grows, one would invest in more businesses, just as someone buying real estate would buy more properties as finances expand.
It is possible to become wealthy investing in stocks. It requires that one thinks like a partner and invests in bussinesses, however, rather than trading stocks. One needs to raise enough money to make substantial investments and one needs to have a long-term outlook.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.