If you invest, the question is always, how do I make money in the stock market?
There are several ways to go about it.
Buffett achieved an annual return of 31.6% in bad and volatile markets. There is a post available here that goes through Buffett’s interpretation of financial statements, all for the purpose of making money in the stock market. But that’s the technical part.
Avoiding Loss of Capital
In the September 2013 issue of AAII, there is a section on debunking stock investing myths. One myth is that paper losses do not matter. Something I was taught when starting out.
Supposedly, since losses are not locked in, they are only temporary. I always found this strange and now I realize that it is wrong.
Stock are liquid assets which are marked to market. If you buy a stock for $1000 and it goes down 20%, it’s foolish to think that the value of your holdings is still $1000, simply because you haven’t locked it in. Avoiding permanent loss of capital is important, but also working to avoid loss of capital is equally important. In the short term anything can happen, that’s why margin of safety is so important.
Tell Me Where I’m Going To Die, So I Won’t Go There
One thing that Charlie Munger does so well is to focus on eliminating the bad and letting the good take care of itself.
“Tell Me Where I’m Going To Die, So I Won’t Go There”Munger
There is a deeper meaning to this quote.
It’s having the power to say “no”. It’s scary, but it works. Instead of trying to find a winning formula for everything, stick to the basics of not doing the things that aren’t going to work.
Say you aren’t as analytical as some investors. Then instead of trying to expand into an area that you are not comfortable with, just stick to something simple.
Buffett called this staying within your circle of competence.
3 Simple Ideas to Avoid in Order to Make Money in the Stock Market
- Avoid companies using obsolete methodology and technology
- Stay away from companies with too much leverage
- Avoid stocks with shrinking competitive advantages
1. Avoid Companies Using Obsolete Methodology and Technology
Kodak went bankrupt by ignoring the fact that film was out and digital cameras were here to stay.
Blockbuster went bankrupt because it was unable to defend itself from Netflix and the new era of streaming and “renting” movies.
Newspapers are on the way out as everything goes digital.
CD’s and DVD’s are dying and that’s why a net net stock like Imation (IMN) continues to stay a net net.
Companies like IBM (IBM) and Seagate (STX) adapted to change and new technology to become stronger. But as Munger said above, it is easier to avoid the bad ones instead of hunting for the next Google.
2. Stay Away from Companies with Too Much Leverage
The whole point of using leverage is to magnify your returns.
There is a long and detailed discussion of whether high debt companies achieve higher returns. In theory, the concept is true, but in reality, it’s very difficult to maintain high returns simply because there are so many different variables that can affect it.
If the economy turns, no matter how good the business is, it can run into trouble.
The first thing in personal finance is to eliminate debt. People are irresponsible when it comes to leverage and many companies are as well.
Going back to how Buffett interprets financial statements, Buffett says that durable competitive advantages carry little to no long term debt because the company is so profitable that even expansions or acquisitions are self financed.
Buffett’s historic purchases indicate that on any given year, the company should have sufficient yearly net earnings to pay all long term within 3 or 4 year earnings period. (e.g. Coke + Moody’s = 1yr).
3. Avoid Stocks with Shrinking Competitive Advantages
This one isn’t as simple. There is a lot of qualitative research that goes into this one. The easy way is to first understand the different types of moats that exist and then to check for yourself.
Lastly, here’s a forum post on measuring competitive advantages.
How Do I Make Money in the Stock Market?
In answer to the initial question, it’s easier to make money by avoiding the things that make you lose money.
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