Conviction Is for Convicts—Oops, Stock Investors

How do you become a successful investor? We all would love to crack the code to becoming a great investor and thereby very wealthy. Although you may not become the next Warren Buffet or John Templeton, you may still be able to outperform the market and enjoy a decent retirement, but what does it take to earn above average returns?

Step One

First, the ability to look at an individual business and its financial performance over a long period of time and evaluate how you think the company will do over the next ten years is critical.  One has to have the skills to think independently when examining the facts of the business.  Some areas to investigate include all financial statements (income statement, balance sheet, and statement of cash flows) to get a good grasp of revenue, operating income, and net income growth rate.  Other financial ratios to consider include cash/debt, debt/EBITDA, forward and trailing P/E ratios, and debt/equity.  One must compare these ratios to other individual companies in the same industry to get a feel for what kind of relative value a buyer might get in each stock within the same industry.

Also, it is highly recommended to read at least one SEC filing for the company, such as an annual report or the latest quarterly financial report (called a 10-Q).  SEC filings are mandatory for public companies and are a great way to obtain all the information an investor needs to evaluate the financial performance of a potential stock to own.  Finally, reviewing the latest headlines and insider transactions can also be a very good source to obtain more knowledge about a specific company, especially regarding their most recent developments and management’s trades in the stock.

Second: Set Long Term Expectations

Stock investors can expect the stock they buy to initially go down.  I would say for the first six months to not even look at the price of the stock you bought.  According to the book ‘Value Investing- Tools and Techniques for Intelligent Investing by James Montier,( John Wiley, 2009, Pp 331, Figure 32.7), 75% of all value created by owning a stock for the long term occurs in the 8^th year, 10%  in the first 3 years, and 15% of the total value in the second 5 years.  So, if you are investing for the long term, think decades, not years or months.  If you are a trader and need profits in 1-3 months, the stock market can be very tough. Bottom line, ignore the short-term movements and focus on long term. If the stock does go up after the initial purchase great, if not don’t worry.

Last, but Not Least

Now to the key point, these are the most important characteristics an equity investor should have to be successful in the stock market; conviction, and patience.   Conviction is a strong belief in an idea.  When investing in the stock market, one’s conviction is going to be tested repeatedly as the stock price moves.  If you cannot handle losing money for a while, and being patient when a stock is down, the stock market is going to be a hard place to make money.  An investor must take emotions out of investing and hang in there when the stock or portfolio goes down. If the company, or companies in the portfolio are profitable, have good financial characteristics, and management is focused on growing the company with a solid plan, in time, the stock(s) will eventually go up.  Without conviction, one should stay out of the stock market, so remember, conviction is not for convicts, it’s for successful investors, especially in the stock market.

Yale Bock is the President of Y H & C Investments, a Registered Investment Advisor based in Las Vegas, NV. Yale has a B.A. in Economics from UC-Irvine, a MBA from UC-Irvine, and has earned the Chartered Financial Analyst  (CFA) designation. He  has been managing clients money for about 5 years and his own money for over 15 years. He can be followed at www.wealthfront.com or www.covestor.com