Money and Finance
In a transcript of a 2008 interview with Buffett biographer, Alice Schroeder, she shared the following observation about Buffett's own process for evaluating new investment ideas:
Dividend investors, for example, can ask "What would have to happen to make this company cut its dividend in the next 3-5 years?" More specifically, if the company currently covers its dividend twice over with earnings or free cash flow, you could ask, "What would have to happen for this company's earnings/free cash flow to be halved?" and thus put the dividend at risk.
- Investing In Your Best Ideas
One of the things I struggle with the most as an investor is knowing how much capital I should put behind each of my investments. Indeed, the biggest mistakes of my investing career haven't been those where I've lost a little money, it's been...
- A Fresh Look At The Simple Formula
Earlier this week, a reader* of the blog had a look at the formula I laid out in "A Simple Formula for Investing Success" and cleverly suggested that the formula should be rearranged from: Investment + Good Company + Right Price +...
- An Important Dividend Cut Case Study
Back in March, I explained why I sold my position in Tesco for a 22% loss. Looks like it was the right move. As of this writing, the stock is down another 25% from my selling price. Worse, the company recently reduced its interim dividend by...
- Investing Is An Expectations Game
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Money and Finance
The Right Way to Approach New Investment Ideas
With most situations in life it pays to go into them expecting the best outcome. No one would take a Hawaiian vacation if they thought it would rain every day during their stay, no one would buy a house if their first thought was all the repairs they'd have to make in the coming years, and so on.
With investing, however, it pays to approach new ideas with a healthy dose of skepticism.
The first step in Warren's investing process is always to say, "What are the odds that this business could be subject to any type of catastrophe risk - that could make it (the business fail)?...It is backwards the way most people think because most people find an interesting idea and figure out the math, they look at the financials, they do a project and then at the end, the (sic) ask, "What could go wrong." (author's emphasis)
Finding new investment ideas can be exciting, but our initial enthusiasm should be tempered until we've first determined the company is highly unlikely to have meaningfully-worse results in the coming years. By doing a "pre-mortem" on our stock ideas, we can save ourselves from making some big mistakes along the way.
However you frame your questions, the key is to approach each idea with a safety-first mindset. Only then can we feel more confident in our subsequent findings.
Related posts:
- 5 Ways to Avoid Permanent Losses
- Introducing the Dividend Compass
- A Simple Guide to Selling Stocks
What I've been reading/listening to this week:
- A lifetime of saving and investing helped a janitor amass an $8 million fortune - Reuters
- Masters in Business podcast with StockTwits founder Howard Lindzon - Barry Ritholtz
- Don't be a doomster - Monevator
- Imitating genius - Matt Brice
- What do low interest rates mean for stock returns - Ben Carlson
- Michael Mauboussin on contrarian investing - via ValueWalk
- A list of good financial bloggers and writers - Morgan Housel
Stay patient, stay focused.
Best,
Todd
- Investing In Your Best Ideas
One of the things I struggle with the most as an investor is knowing how much capital I should put behind each of my investments. Indeed, the biggest mistakes of my investing career haven't been those where I've lost a little money, it's been...
- A Fresh Look At The Simple Formula
Earlier this week, a reader* of the blog had a look at the formula I laid out in "A Simple Formula for Investing Success" and cleverly suggested that the formula should be rearranged from: Investment + Good Company + Right Price +...
- An Important Dividend Cut Case Study
Back in March, I explained why I sold my position in Tesco for a 22% loss. Looks like it was the right move. As of this writing, the stock is down another 25% from my selling price. Worse, the company recently reduced its interim dividend by...
- Investing Is An Expectations Game
A thing long expected takes the form of the unexpected when at last it comes. - Mark TwainIn such a low-interest rate environment, why would the market allow companies to trade with 8%+ free cash flow yields -- even after considering a reasonable...
- Dividend Reinvestment
Hi Everyone, I was thinking about what I have left out with regards to my investing style and it hit me: I have not discussed whether or not I reinvest dividends or I "bank" the money and use it all at once to purchase another stock that I feel...