I may earn money or products from the companies mentioned in this post.
Look, let's face it, from the get-go we're told over and over we're better off letting someone else manage our investments. It's too complicated they said. It's too time-consuming they said. Why would you spend time on investing when a “professional” can do the job for you?
But come on. They mostly don't know any better than you and even when they do, they swindle you without remorse. And hell, even 99% of mutual funds underperform the market. What are the chances your genius financial advisor is going to do better? Mine certainly didn't before I got rid of him.
Sure, it takes a lot of work to learn when you're starting from scratch as I did. But I'm telling you it's so worth it. For example, take today. The market plunged almost 3% and everyone is freaking out about a recession. Four years ago I would've freaked out and sold everything. Now, I'm honestly a little relieved.
I know every time the media thinks the market is headed into bear territory it pretty much never happens, but now instead of freaking out, it's comforting. I have money to put to work! And I've finally conditioned myself to welcome a down market instead of fear it.
If you want to be a better investor, you're in luck.
Here are 5 ways you can become a better investor
Learn what is the difference between investing and speculating
This is key. People often interchange the two thinking speculating is the same as investing. But in reality, when you're speculating, you're gambling. People who use charts and speak of the beloved “charting” method are doing nothing more than guessing. They're speculating the stock is going to go a certain way whether that be up or down. Honestly, it's a bunch of garbage. Just go to the casino and guess if that's what you're into.
Investing is a different ballgame. You're not looking at some resistance point in the stock or whether the stock price made a jump and created a gap in after market hours. You're doing research on the company. You're doing researching on how the executives get paid, their competitive advantage, their industry, their dividend history, their competition.
It's a ton of work, but if you can have the focus and the patience for it, you'll honestly make millions. It's all about having a long-term frame of mind and realizing that what it is you want to do is really invest and not speculate.
Know what makes a great company
This takes some time as a beginner. When you're first starting out, you'll want to read a lot of books and listen to a lot of podcast episodes. A few great ones for this is The Essays of Warren Buffett, the Berkshire Hathaway shareholder meetings going back until 1994 and How I Built This.
With these sources, you'll learn the characteristics of what makes a company thrive and fail. One of the most important things is great management and leadership. In the short-term it doesn't seem like this is a super pertinent criterion. But over even a few years it's probably the most important especially considering how quickly technology is changing companies these days.
Just look at the difference in leadership between Apple and the former Enron. Big difference there obviously and the stocks of the companies reflected that. One became the largest company by market cap at one point and the other dissolved. Ken Lay and Jeff Skilling became two of the most corrupt executives to date.
You also want to see how an executive is being compensated. Is the CEO's salary quadruple the second-highest-ranking person or is it pretty much equal? Is it tied to stock on performance-based merit?
At my fiance's previous job the CEO was being paid $7 million while the company was losing money. The company almost went bankrupt and had to layoff the whole team and the stock is down 99% in less than a year. Not even kidding, go check out Prometic Life Sciences' stock. Watch out.
You also obviously want to make sure a company is transparent about their financials. And don't listen to them if they talk about EBITDA. It's the most cowardly move you can make as a company. It's basically avoiding telling the truth. For those who don't know, it stands for earnings before interest, tax, depreciation, and amortization.
That's the equivalent of you saying “yea I won the Powerball except I didn't hit the first, second, third or fourth number.”
Another thing you want to look for is if they're allocating enough resources to research and development and if they're getting rights to patents and intellectual property. You always want to make sure the company you're thinking about investing in is staying ahead of the curve. You don't want them to become the next IBM. Look at Apple for instance. Every day they're filing for patents and making acquisitions. You need to know your company won't get left in the dust in 10 years.
- The Best 3 Money Moves to Make in Your 20s
- The Best Investing Books to get Rich
- The 9 Best Things to Research Before Investing in a Mutual Fund
- Which Mutual Funds to Invest in for 2019
- Investing for Beginners
- Is $1 Million Enough to Retire?
- 71% of People Don't Realize They are Paying Fees in Their 401k Plan: Here's How to Take Action
- The 10 Questions to Ask Your Financial Advisor ASAP
- 66% of Americans Are Losing Hundreds of Thousands of Dollars: How to Fix it
- The #1 Mistake Costing You Millions
Condition yourself to appreciate a stock dropping in price
This is probably the toughest thing to do. When you first start, you panic about every little piece of bad news and drop in stock price. But in reality, when you think about it, it's just the news. The news is always bad. Nobody wants to read about a kitten saved from a tree or someone helping an old lady cross the street.
The bad news is what gets views. But it's also what can make you go broke. Realize there are humans who need jobs who are publishing this news. It's self-serving. It's also published by people who usually don't know what they're talking about or worse don't even care if it's right or wrong.
For instance, this guy Gordon Kelly at Forbes. He's a clown. All he does is publish negative clickbaity headlines about Apple. It's actually hilarious because 90% of his stuff is wrong. If anyone knows anything about the technology industry and reads his work, they'd laugh. And yet, he's a Senior Contributor, go figure.
The point is, when this happens, you need to reprogram your brain to realize this is an opportunity to invest. When the stock goes up, you're too late. When it goes down, you most likely panic. Research from Daniel Kahnemann in Thinking, Fast and Slow shows that losing an amount of money is twice as painful as it is to gain the same amount.
This is why we do so poorly investing. We don't condition ourselves to do the opposite. You need to appreciate when the stock of a great company is going down and be dismissive of a stock when it's astronomically high.
Understand some factors to look for in a cheap stock
One of the first things to look for is a low P/E ratio. This is short for price to earnings ratio. The price is referring to the price of the stock in relation to the company's earnings. The higher the ratio means the higher the price of the stock.
Now alone this is obviously not enough to indicate whether something is a good investment or not. But typically, it's usually a good indicator to know whether it's too late to invest or worth doing more research. Right away for most companies if it has a high P/E ratio, you're probably late to the party.
Now some might vehemently disagree, but you're looking for safe investments, not betting on the chance the stock will go up just for the sake of it.
You need to research the competitors of the company you're interested in. Look at how those companies' stocks are being valued relative to the one you're interested. Is the company's stock you're interested in much lower or is it 50% more than the closest competitor?
This is a good indicator as to how others value these companies and if there's room to grow.
You also need to research competitors because you need to see what competitive advantage the company you're interested in has. Is it something that isn't likely a competitor can match? Or is it something like cloud software that multiple players are steadily creeping in on? Ultimately it's your call, but it's one of the most important and overlooked components when choosing a company to invest in.
How strong is the brand name?
This is huge. Don't invest in something because you heard the earnings are supposed to be great for the next quarter. If it doesn't have a strong brand name, it's probably not a good idea. Yes, of course, there are exceptions, as there are for pretty much everything else listed here, but for the most part, it's a good rule to abide by.
Sure, you can argue a strong brand had to start somewhere. But do you really need the aggravation of sleepless nights? Brands like Apple, Microsoft and Berkshire Hathaway aren't going away anytime soon. They won't have the same ridiculous performances as they did in the past because they're so big, but they're reliable companies with huge moats.
Debt to equity ratio
Debt to equity is the company's debt divided by the shareholder's equity. It's the proportion of equity and debt the company is using to finance its assets. This is very important because it's used as an indicator to tell whether the company is capable of paying all of its outstanding debts or not in the event of a downturn. It helps to see how much leverage the company is using.
If it's using a lot of leverage, if there's a recession, it's going to be difficult to tough it out. This is one of the reasons investors are very concerned about WeWork. They have a tremendous amount of debt and since there hasn't been a bear market in a long time, investors aren't confident in the company's upcoming rumored IPO.
Return on equity
This can also be referred to as a stockholder's return on investment. It's a measurement of the rate in which the shareholder is earning income on the shares they have. The return on equity is net income/shareholder equity (total assets-total liabilities). It shows you how well a company has managed its investments to produce earnings growth.
This also needs to be compared with the company's competitors. Sometimes the industry ROE is only 10%. If you're comparing this to say Microsoft which is currently at 53.5% as of June 2019 and the company is a furniture store with a 10% ROE, then that does you no good. Compare it to a Bed, Bath and Beyond or a Home Depot (which is negative) for a better indicator.
Buy a stock of a well-known company and follow your investment every day
People including Warren Buffett will say invest in a stock and don't look at it for a year. But if you want to separate yourself from the amateurs, look at it every day. That's right. Every. Single. Day.
If you want to truly understand how wild the markets act in good times and in bad, go on Google and read the news of the company's stock you just bought every morning. Then watch how the stock does that morning and how it ends up when the market closes.
At first, it's tough simultaneously watching and preventing yourself from selling when there's bad news or buying when there's news something good happened. Just sit there, don't do anything but observe. This was the best education for me more than anything else. It made me realize how cynical the reporters and editors are of large media platforms like Forbes, Fortune, etc.
And when you read news of the company on the Wall Street Journal or CNBC, watch how the market reacts. Once you get a sixth sense for this and feel comfortable checking the stock every single day without buying or selling, then you're ready.
You'll get anxiety in the beginning. I did for so long. But now I'm over it because I know how everyone is going to react, good or bad news. Just stay focused and you'll be fine.
So if you want to get started to become a better investor, begin here.
Like what you read?
Join all of us to get the latest posts on how to make, save and invest more. It's the only way to your financial freedom. In addition, you get the FREE Coffee Habit Worksheet to track your minor spending and see how it's really costing you over the long-term.