Key Principles to investing in a stock

In this article we look at the four keys that we believe every stock investment should have. These are not new things but rather the core principles that successful investors have been following for decades. These guidelines makes a good ground for you when making a decision to start investing. 

Invest in sectors and industries that you understand

Becoming an expert in certain areas of the market will give you an upper hand when it comes to selecting stocks to buy. This is like a foundation for all other steps that follows. Pick a given sector or industry and try to get information on it as much as possible. This will enable you to make informed decision when it comes to buying stock.

Find companies with a Long-term Competitive Advantages 

Companies with long-term competitive advantage have an ”economic moat” i.e. Economic protection.  These companies have the following advantages:

• A recognized brand.
• The ability to produce products cheaper than anyone else.
• The ability to sell their products cheaper than anyone else.
• Barriers to entry that make it difficult for competitors or new companies to compete.
• The opportunity to grow at a cheaper cost than anyone else.
• A duopoly situation where two companies dominate the industry like Airbus or Boeing.
• Networking effect where the users of the product or service makes the business more valuable like Google.

Look for companies with Excellent Management

This can be done by reading annual and quarterly reports and studying the history of the company’s current management in an attempt to understand what the management is currently doing and what they may do in the future. You can look at the following:

• The management’s history of decision-making. Do they have a track record of someone who we would actually hire if given a choice?
• Understanding how management is compensated. Is their compensation based upon the success of the firm?
• Ensuring that management is shareholder friendly. Do they do things that have the best interest of shareholders in mind?

Related: What to consider when making an investment plan

These questions will help you to answer the question as to whether or not we trust the management enough to purchase the stock.

Buy When the stock is at a Good Price. Discounted to Intrinsic Value

Find stocks that are currently trading below the market price. If you can be able to find stocks that are trading below their intrinsic value and have the other three core principles then we would have the formula for a sound stock investment.  If you find a stock with the first 3 principles but is not trading below the market price, then it is better you wait. Any investor should know that the price at which he/she pays at, is a critical piece of investing. If you get it wrong then the investment will have a hard time making money.

Bottom Line

When all the four principles align then the possibilities of making money increase, though this does not guarantee that you will make money but rather increases the probability of making money.

Also Read: Common Investing Mistakes you should avoid