Saturday, March 31, 2012

a framework for investing in the stock market

Warren Buffett famously said: "To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding the framework."

A big reason why I blog is to preserve the framework I use. Reading past entries allow me to revisit the ideas from various sources that have influenced my investing style. When it comes to putting money in the stock market, here are some guidelines:

1. assess the management - If you manage your own business, you know for a fact that no one could possibly do it better than you. But when it comes to companies whose stock you would like to buy, how do you know that management is doing their best. Check if they have achieved previously stated objectives, check measurements like earnings per share growth and revenue growth, check surveys that publish the most admired and well managed Philippine companies.

2. assess its financial health - one word: cash flow. A company with good cash flow will survive even if its management is incompetent. This is especially true for companies with a firm grip on its market.

3. understand its principal activities - when you buy a company's stock, you own that company. You should therefore understand how it makes money, how can it expand and what are the threats facing its business model.

4. assess its outlook - the stock market is forward looking. the record levels we currently see in the Philippine Stock Exchange means that investors have a rosy outlook for the companies in the exchange. The opposite can also happen, investors can also leave in droves if current events turn sour. This, however can present opportunities to buy stocks at a cheap price if you think that a company's outlook will remain strong despite general economic uncertainty.

5. stick to the framework and don't let your emotions rule - Here's a thought exercise: Let's say you have 500,000 invested in the stock market. The next day a military coup takes over Malacanang and assumes power. Foreign investors withdraw their money and as a result the stock price falls. Your investment is now worth 250,000. If you stick to the framework, you will leave it as it is. But if you panic and follow your emotion of fear and uncertainty, you will also withdraw your investments with a 250,000 loss. Let's say after 1 month the coup is quashed and civilian rule returns. Foreign investors move their money out of Europe because of Greece and Spain defaulting. They then see that the Philippines is still a good place to invest and stock price slowly move up. After 8 months, the value of your stock investments is now worth 510,000. In a span of 9 months, you could either have earned 10,000 or lost 250,000. It all depends on whether you can keep your emotions in check.

Happy investing!

Saturday, March 17, 2012

living rich vs being wealthy

They may sound similar at first, but there is a big difference between living rich and being wealthy. Living rich is what most people aspire to. Live in a big house, drive a fancy car, go on expensive holidays and have all the trappings of life money can buy. Unfortunately, however, someone has to pay for it. Most likely by slaving away in the corporate world and sacrificing a big portion of your time to earn cash which you spend freely. Therefore you need to exert more effort as years go by since money flows out as fast as it comes in. You live in fear of losing your source of income because you are so used to living the high life.

Being wealthy means living below your means. This means driving a used car, living in a mid size home, staying at a 3 star hotel, buying things when they are on sale. This allows you to save your excess earnings and invest them in assets that appreciate in value. Over time, these assets will grow and eventually provide you with income. You then don't have to exert a lot of effort into maintaining your lifestyle. This is made easier since you don't need a lot of money to live the life you are accustomed to anyway. This means you have more time for leisure instead of time devoted to earning money. Having such assets allow you to feel secure that you can rely on something during difficult times.

Being wealthy is what investors strive to achieve. Being wealthy is a habit, it is a lifestyle worth emulating. Being wealthy allows you to have something that money cannot buy: peace of mind and quality time. Happy investing!

Tuesday, March 6, 2012

defensive investing advice from Dr. Doom

I would like to share a reading from one financial newspaper who interviewed Dr. Marc Faber a.k.a Dr. Doom. He often appears in the media with a very bearish outlook, hence the nickname. But I for one liked what he had to say about investing during these volatile times. Basically, his advice is very similar to Browne's permanent portfolio, which I have shared previously. Dr. Faber is advising investors to spread their investments into:

25% stocks
25% cash and bonds
25% precious metals
25% real estate

Not a bad asset allocation strategy. Its simple to follow and you only need to rebalance your investments from time to time to compensate for those that have increased or decreased in value. Particularly this time when Philippine stocks are at a record high and gold is still above $1600 an ounce. Perhaps the next several investments you can make would go to cash or real estate. Happy investing!

Monday, March 5, 2012

angel in the marble

Many speakers often use this story and it can be applied to different situations. I for one find it very relevant to investing. The story is about how Michelangelo created the statue of an angel in the Basilica of San Domenico in Bologna. He said, "I saw the angel in the marble and carved until I set him free." While everyone else sees a block of marble, Michelangelo has the vision of a beautiful artwork and he made it a reality. This mindset is what separates great artists such as him from mediocre ones. I believe this is what separates successful investors from those who lose as well.

Good investors "see the angel in the marble". They see the future potential of their investments, even if most people don't and they have the patience to wait for that potential to be realized. It could be a stock whose price is driven down by temporary setbacks, or a block of land in the middle of nowhere with tourism prospects, or a business idea that others dismiss as ridiculous. When the time comes for the stock's price to rise, or for the land value to increase or for that business to turn out a profit, the investor will have realized excellent returns from his investment.

Happy investing!