Our Thought Process For Investing In Stocks

As a do-it-yourself investor, I enjoy the process of investing much more than finding my next company I will invest in. Admittedly, the process is much more challenging than finding the winning stocks. Yes, you read it right! Investing process is very difficult in many different contexts. Managing the portfolio requires wearing different types of hats. Sometimes you have act and behave like a leader, sometimes play the role of manager, and on many occasions you work like an employee. Originally posted here.

Most of the investors spend a significant amount of time in looking at the quantitative part of the company analysis. We arrange data in different formats, different time scales, compare with analyst, check out google to see what others have to say, etc. In short, search and screen multiple stocks, collect data, and present observations and results. This is all about execution and is similar to what an employee will do. Is that really important?  Have you asked yourself?

·          Why this specific type of analysis?

·          How you determine earnings per share?

·          Is it only necessary to look at last one year or last three year or more?

·          Do you include dividends?

·          How do you decide multiples?

·          How do you decide value?

These are all tactical aspects that are telling you how to analyze companies and what parameters to look for. As an example, let us assume you have more than 10 companies that pass your criteria, or you have list with mixed results. Do you know what to do? That’s where a manager puts your analysis in the context of total return or time frame. Managerial perspective puts multiple options and scenarios in the context of a pre-defined strategy.

·          Which sectors to invest in?

·          Are we increasing risk?

·          Are we maintaining allocation or diversification?

·          Is there liquidity?

·          When should we buy or sell?

·          Mutual funds, index funds, ETFs?

·          Cash or short term investments?

Your strategy will decide which tactics (i.e. scenarios or options) will have higher chance of success. Your strategy helps deciding which tactics you have to execute to give you desired total returns in a given time frame.

·          Does technical analysis, momentum, or swing trading make sense?

·          Does fundamental analysis make sense?

·          Top down? Bottoms ups?

·          Which type of companies you will buy-n-hold?

·          Which one will be short term opportunities?

·          Which one will be arbitrage?

But then, how do you decide a strategy? You could adopt different strategies which contradict each other? Or they are confusing enough to hinder clear path. This is why clear goals are important. Goals have to be defined in such a way that they are specific and one can visualize them.

·          What is our goal? Can you see 10 years or beyond?

·          Can see as far as next year only?

·          Which one matters the most 1 year or 10 year?

Most of us keep working like an employee spending inordinate amount of time in slicing and dicing the company balance sheets. We keep looking for the next winning stocks. But does that help us reach our 1 year goal or 10 year goals?

Majority of investors have superficial goals which in turn confuse their strategy.  Tactically, they keep jumping from one stock to another in searching of those elusive multi-baggers. Identifying one or two multi-bagger or a brilliant stock pick will give you bragging rights in your daily chit chat, beyond that it has no meaning. Multi-bagger or few winning stocks in a given year is not going to help if your goals and strategy is messed up.

In my view, the biggest mistake in setting your investing goals is not able to set a long term goal. This ignorance poses the highest level of risk to our portfolios.

·          Losing little bit of money in one or two stocks is not your biggest risk

·          Stock market tanking is not your biggest risk

·          Slowing of economy is not your biggest risk

·          Reduced EPS in next quarters or next year is not your biggest risk

Your biggest risk is not able to meet your investing objectives in 10 years or beyond. The biggest risk is not able to develop and maintain asset base that is large enough to meet your needs in 10 years or beyond.

So as a do-it-yourself investor, you need to spend more effort in trying to remain focused on your goals and strategy. You have to put your portfolio build up and stock analysis in the context of your goals.