I’ve come to a realization: It’s time to rethink my investing strategy when it comes to buying individual stocks.
My previous plan:
- 401(k) for long-term investing geared toward retirement age.
- Use small amounts of my extra monthly income to buy individual stocks with the idea to receive a better return than a regular savings account.
While I haven’t suffered huge losses with this strategy, I have made some bad decisions that either lost a little or gained next to nothing.
After some deep diving research over this past weekend, I’ve come to the conclusion I need to change my approach. This new approach is more in line with Value Investing and the principles of Warren Buffett.
Value investing is an investment strategy that involves picking stocks that appear to be trading for less than their intrinsic or book value. Value investors actively ferret out stocks they think the stock market is underestimating. They believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond to a company’s long-term fundamentals. The overreaction offers an opportunity to profit by buying stocks at discounted prices—on sale.Investopedia
One of the biggest flaws in my previous stock buys has been I simply don’t know enough about the companies and the potential for them to do well.
Recently I’ve been buying a lot of pharmaceutical stocks and other bio-tech companies. These companies have massive upside potential according to the analysts and the news they put out. But at the end of the day, how do I know if it is true potential or just hype?
The answer is I don’t.
I’m breaking a critical rule of successful investing: Only buy what you understand.
All of these breakthrough therapies and medications these companies are researching sound very impressive. But will they ever make it to the marketplace? If I’m being honest with myself, I have absolutely no idea.
So, I started thinking about the businesses and industries I know to a certain extent and what I can understand.
That search lead me to the idea of value investing.
To my understanding at the moment, value investing makes a tremendous amount of sense.
- Find companies with strong long-term revenues and sound accounting principles.
- Look back at the stock price over a period of time.
- Watch for the stock price to become overvalued and go through a correction.
- Purchase shares only when the price is within a target range to reasonably expect solid gains.
How To Execute The Value Investing Strategy
The concept is simple enough. It’s the execution that is tricky.
First, this investing strategy takes a lot of research and patience. You have to dive deep into the price action of the stock and find the ones that are solid companies with growth potential for years to come. Then you have to wait to buy it.
This strategy is very contrarian in nature. You aren’t necessarily taking part in the hot stock of the day or the week. You’re looking at the ones that aren’t on people’s radar.
On top of all of that, you’re also waiting for the price to fall significantly. Depending on a lot factors, that could be months down the road.
Second, you’re looking for a company you believe in and can understand.
In my case, I started thinking of brand names of products and services I have used for years that aren’t going anywhere any time soon. Sure their stock price may fall (in fact that is what I want to buy in,) but I know the financials of the company and the strength of the brand and their product will rebound and grow with time.
So, we wait and wait some more. Then, when the price is low enough, we buy in and let the rest take care of itself.
This strategy is a little more long-term than I had hoped for my individual stock buying. But my recent failures (or less than impressive successes) have brought me around to a new way of thinking about my strategy.
Do I want to spend the next 3 months chasing the market daily in search of a needle in a haystack? Or, would I rather exercise a little patience and put my hard earned money into a stock with a proven track record?
It’s a pretty easy choice when you break it down.