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I See My Readers Making This Mistake Over and OverBy
Friday, November 4, 2011
When I read notes from my subscribers, I see the same mistake over and over...
Based on the questions they ask – and the complaints I get! – my readers believe investing is primarily a system for picking bottoms in the share price.
That's not true at all...
To be a successful, long-term investor, you need to realize that you shouldn't waste time trying to predict the future. What I do is not about projecting "price targets" on stocks... and it has nothing to do with guessing which direction "the market" is going to go.
What I do is all about finding one thing...
Successful, long-term investing is all about finding – and buying – the best businesses at cheap prices.
That's it.
If you're a regular DailyWealth reader, you know what the best businesses are. It's a group of stocks I call World Dominators... elite blue chips like Intel, Microsoft, and Johnson & Johnson.
I know I can't predict the future. I don't know where the S&P is going to be in one week, one month, or one year. When it comes to analyzing and recommending these kinds of stocks, I don't need to concern myself with any of that stuff.
I just need to know if these companies have sustainable competitive advantages, strong balance sheets, fat profit margins, and a commitment to treating their shareholders well, through rising dividends and share buybacks.
And since I realize that I can't guess the future – even for World Dominators – I make sure my readers buy these stocks at a discount to my appraised values.
The difference between the value and the price you pay is your margin of safety (or margin for error). It's how you account for an uncertain future.
Business value is subjective. It takes into account how well you expect a business to do down the road. If you could know precisely how well a business was going to do over the coming months and years, you could establish its value precisely. But since you can only guess what's going to happen, your estimate of the business' value can't be entirely precise. That's why it's best to buy only at a discount.
Now, I know World Dominating stocks are valuable. And I'm not alone. Procter & Gamble bought Gillette for 30 times free cash flow. InBev bought Anheuser-Busch for 28 times free cash flow. And Mars bought Wrigley's for 32 times free cash flow.
All three were bought by the most knowledgeable people in their industry. The world's greatest investor, Warren Buffett, was in all three deals and gave each his blessing.
So these stocks are worth about 30 times cash flow. But I can't know the future, so I want to buy at a discount to that. If you can find these stocks selling for around 10 times cash flow, you're set. You don't have to worry about what's coming down the road for the market or the economy.
You don't have to try to guess the future. You know you own a valuable company at an unbeatable price. You can hold through whatever comes.
Long ago, I gave up looking for "hot tips" or guessing what the future would hold. I only became a successful investor when I gave up the hopeless idea that one can successfully invest by guessing what the future will look like. You can't.
The future is unknowable, unpredictable, and it will be risky. There's no getting around that. As an investor, you can mitigate this risk as much as possible by buying the best businesses at cheap prices.
Good investing,
Dan Ferris
Further Reading:
Most investors are terrible at making buy and sell decisions. They let their emotions dictate what they're doing. But Dan has a way to avoid that. Learn how here: This Information Is Worth Literally Thousands of Dollars.
"Beginners often jump in and out of stocks based on one or two days of price action. They lose money," Dan writes. Surprisingly, there is an easy way to gain a huge leg up on the rest of the crowd. Get the full story here: An Immense Investing Advantage Anyone Can Achieve.
Market NotesHOW TO MAKE A LOT OF MONEY IN GOLD STOCKS The recent price action in gold stocks is why "buy on pullbacks" has become a useful trading cliché...
Just over a week ago, we pointed out how the big gold stock fund (GDX) presented a low-risk, potentially high-reward trading opportunity. This trading idea has been a winner... Gold stocks have ripped higher.
As we've profiled many times, gold stocks are cheap right now. And higher gold prices are putting the wind at their back. But they've suffered big selloffs at various times this year. With the bullish fundamental setup for gold stocks, these selloffs make interesting opportunities to trade from the long side.
To illustrate this idea, we present the past two years' trading in the GDX. At the bottom of our chart is an extra "window" that displays an overbought/oversold indicator called "RSI." When the RSI is over 70, gold stocks are stretched to the upside and due for a correction. When RSI is below 30, gold stocks are stretched to the downside and due for a rally. Each time the GDX has reached oversold levels, it's been a good bet to rally... or as the cliché goes, "Buy on pullbacks!"
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