Win your game even before you begin
Of late, this market adage has become more and more important than ever: “Win your game even before you begin.”
This is actually the first cardinal rule in stock market trading following the basic investment principle to “buy low and sell high.”
Precisely, the market rule demands that whenever you enter a trade it is important, if not imperative, to secure (or pick) a winning hand beforehand.
Yet, just how many times have most of us ended our trades at the losing end? A long experience in the market had not been a guarantee.
One fault found that is observed to generally apply to most us is that we oftentimes forget or ignore what is needed to be done. We become either oblivious or negligent of our duty to observe due diligence.
Instead, we give in to the path of least resistance that when allowed to prevail, will readily transforms into a habit. If this happens, this makes us more of a market loser than a sure winner.
This rule is simple but is not that easy to follow. It requires utmost discipline and consistent practice.
First rule is to choose a stock of a company whose business is considered a “great investment” more than being a “wonderful investment.” The two are very different. Knowing the difference could tip the odds of the market to our favor. It will always keep us stay ahead of the crowd, so to speak.
The picture painted about a wonderful investment is a company whose stock is trading almost 100 times earnings. It would be this sizzle in the company’s stock price that would dazzle investors to make it a wonderful investment. Things that matter most to a company’s valuation are downplayed or simply lost in the stock’s consideration. Good free cash flow, healthy debt structure and debt service ability, asset turnover and the like, among other operating efficiency concerns, are thrown to the back seat.
The company’s financial fundamentals are further subordinated to the company’s stock market performance. Oftentimes, too, the prices of a wonderful company’s stock would go up or down in a desired way on a given day.
In contrast, a great investment is a company whose stock valuations are created by its business and financial performance.
A simple way to arrive at it is to treat buying a stock as a way of becoming a part owner of a business. This will lead us to our instinctive way to know a great business and investment.
Great investments are made up of companies whose stocks actively hug the regular list of top price gainers of the week. Their market capitalization is not miniscule nor their capital too small.
These companies have a relatively good record of profitability. And when they are in a losing year, they are hardly beaten down.
Of utmost importance, great companies, while fast growing, should be able to somehow generate some free cash flow. Companies with negative cash flow from operations will have to seek additional financing either by borrowing or issuing more shares.
On one end, borrowing increases the risks on the viability of the company. The prospect of issuing more shares, on the other end, dilutes ownership in the company.
The exception to this prime standard is if the company has a solid return on capital or ROE, the minimum of which is at least 10 percent. The hurdle rate is, however, adjusted higher or lower depending on the industry norm.
A great investment is a company that posts consistent reasonable growth rates. If its sales are erratic or extremely volatile, the company’s management is possibly inept or that it’s regularly shellacked by competitors. Either way, the company would not qualify as a great investment.
The only exception to this is that if such performance of the company is generally true to the industry’s overall current situation but the long-term outlook is good.
Also a critical standard to what makes a company a great investment is that it has a clean balance sheet. A company with lots of debt is not ideal to invest in. Due to its debt situation, its capital structure is often very complicated. More than that, we can surely expect more debt in a highly leveraged company.
Bottom line spin
There are more standards that need to be presented as to what would make a great investment. Suffice to say, however, that the foregoing are but the prime standards.
In this connection, the best tool to use following the demand of the foregoing market adage is fundamental analysis. It can aptly capture the underlying valuation or intrinsic value of a company. Chart patterns and technical analysis, while they are likewise fine tools to win our game they fall short of the ability of fundamental analysis to capture and approximate business values and company valuation.
Comparatively, technical analysis is effective in building wealth. Technical analysis could only give a hazy glimpse on the twist and turns of a stock price. It is unable to predict the future value of a company’s stock.
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