I have been meaning to write a post about my investment philosophy for a while.
In this post, I answer common questions and let you in to my method of thinking and how I invest.
Without further ado, here I go:
How do I pick which stocks to buy or sell?
First, I only pick stocks/companies that have a positive cash flow.
I believe, if a company is not held back by too much debt, it can invest its resources to grow the business and profits. If a company knows how to manage its assets, it has a higher chance of staying in business for a while.
Although I don't like it when companies have negative operating costs or some debt, sometimes it makes sense for companies to have some managed debt and some net losses as long as these steps where made to grow the business. An example of this is Amazon (AMZN). Amazon recently reported a net loss in operations for most of 2012 (this hammered the stock price by the way) due to its investment in the Kindle Fire. Amazon spent money for hardware and content acquisition with the hopes of growing their market share in an Apple-dominated tablet market. The Kindle Fire proved to be the most promising competition against the iPad and perhaps this investment would pay off eventually.
Second, I usually pick stocks/companies that pay a dividend.
Getting paid a dividend is like getting paid to invest in a company. Dividends increase the yield of the purchased stock. Dividends also help investors manage the Market's volatility. As long as the dividend is safe (or increased), the stock can go up and down in price and it will still be a great investment. An ideal situation would be having your stocks go down in value while holding the dividend payout making the stock an accidental high-yielder. This makes it "cheaper" to own the stock while getting the most yield per share. Another dream situation would be the company announcing an increase in the dividend pay out. This will increase the dividend yield and (most of the time) increase the stock price.
Lastly, I pick the companies whose products I know and use (or I know someone who uses the products).
I like to invest in things/companies that I know.
I know how Apple makes their money (hardware and software sales). I know how hard it is for smokers to quit smoking (hence, MO will always have customers). My workout clothes are LULU and almost all women wear LULU (and is expected to grow and has brand loyalty). My kitchen pantry has a lot of Kraft products.
You get what I mean.
Knowing how the company makes money is key on finding out whether or not the company is REALLY making a profit. Buying stocks blind is not investing. It is gambling. Think of all the Tech Bubble wash outs during the 2000 Bear market. When it comes to your money, ignorance is not bliss.
How do you know your stocks will go up in value?
I don't. I don't claim to be a Wall Street expert. I also don't have a crystal ball. My investing process includes research and gathering information. Observing what's hot or not can be the difference of making or losing money. I wish I had bought Deckers (DECK) the first time I saw those UGGS shoes.
I also accept the fact that I cannot time and predict the market. You win some, you lose some. I missed the $90 Apple stock price in 2008 (I was busy paying off debt). But I got in at $350 and now, I'm happy with the results. Another thing about the market, do not chase the rallies. There are other opportunities somewhere.
What gave you the confidence to try buying stocks?
Having disposable income gave me the confidence to get in the stock market. Being debt free and controlling my expenses freed up my income to have some room to invest. I also read books and educated myself on how to invest properly. I mentally wrote off my stock market money as money I can afford to lose. This lessens the pressure to pick the right stocks and this protects me from being too bullish.
Also, this keeps my sanity whenever the stock market goes down.
It also helped that Jim Cramer's show was very entertaining. Although I do not solely rely on Mr. Cramer (you shouldn't) his show made stock picking accessible and less frightening.
Finally, I took the time to learn as much as I can (legally) about the companies I invested in. This meant reading trough annual and quarterly reports, analyst's reports and news reports. All part of the homework required to keep my money safe.
Do you buy and hold or do you sell your stocks?
As of today, I have not sold any of my positions.
My positions are too small to break me or make a difference in my lifestyle. But eventually I will sell some and lock in the profits.
Buy and hold is dangerous. Think about all those people who bought and held Enron stocks. Majority of them doubling down and used most of their savings/income and borrowed money to buy and keep Enron. If only some of them questioned the astronomical rise of Enron's stock price, they would have know it was fraudulent and would eventually drop like a hot potato. Unfortunately, they found out too late.
That is why, I buy and do my homework. Take Apple as an example. I keep my ear on the ground and listen through the rumors, product announcements and market trends. If I find out one day that Apple lost its luster, I'll sell the stock faster than you can say iPad.
It is tempting to keep buying Apple especially during its rise to its current over $500 stock price. However, I prefer to balance my portfolio with different companies (from different industries/sectors) to hedge my bets. At least if Apple drops in price, my other positions would hold my portfolio afloat.
Where do I get the cash to invest? Do I buy stocks using a credit card?
First, I will never buy a stock on margin.
Buying on margin means borrowing money to buy stock with the hopes of the stock price going up so that the investor can pay back the borrowed money. This is very dangerous. You will put unnecessary pressure on yourself to pick the right stock and time the market. DO NOT DO THIS.
Second, as I mentioned before, I keep my expenses in check and use whatever is left over (after allocating some cash to savings and my ROTH IRA) to buy more stock. This is the best way to grow your wealth. Minimize expenses. This doesn't mean eating rice and beans forever or living with your parents. This just means prioritizing what you need and want to spend money on. As an example, I barely spend money on my car (except for gas and maintenance) and clothes but I spend money on food, groceries and vacations.
Any tips on how to maximized earnings and minimize losses?
Jim Cramer likes to say: "Bulls make money, Bears make money but Pigs get slaughtered."
This only means that it is VERY BAD to be greedy. The old Gordon Gekko "Greed is Good" mentality no longer applies. So, if your stock is running high, the temptation to double down and hold on is really strong. Cramer suggests "locking in" your profits and reward yourself (by buying a nice sweater). You can no longer lose money you already earned (unless you spend it). Cramer's style is to slowly sell out your positions in 25% chunks to lock in profits and still be in position to make more money if the stock keeps going up.
ex: if you have 100 shares of Apple and you bought them at $400, you'll sell 25 shares at $500 (25% or $100/share gain), sell another 25% at $550 (38% or $150/share gain and so on.
The ideal situation is that your position has gone up high enough for you to take out your initial invest and you are playing with the House's money. In this case, even if the stock drops in price, you did not lose any principal investment.
This method is also applicable when leaving a loser of a position. You lock in losses gradually so that you might catch a small price rebound which would minimize your losses.
As I mentioned above, I have not sold any of my positions because they are not large enough to actually make me money (after fees and taxes). One more thing from Cramer, do not fear the tax man. Yes, you'll get charged regular income taxes on gains from investments kept for less than a year (say, 25% tax) but if your investment is up 50%, why risk losing the 25% gain?
Finally, I always check my investments. No, I don't day trade and I don't panic on a down day. What I meant was I check if the companies I own are still growing or in a good position. Are they increasing/decreasing the dividend? What's their earnings per share? Cash flow? Outstanding debts?
If only stockholders of GM, AIG, ENRON and etc. kept a close look at their companies' fundamentals, they could have gotten out of a painful beating. I try my best to keep my companies in check.
So that's it. My basic investing philosophy. I plan to use this even when investing on assets aside from stocks. I still have to diversify my portfolio and that means adding real estate and other assets... but that would in the near future.
I hope this helps you in your investing strategy.
