Three Wonderful Words for Successful Investing
Keith is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Lots of words are bandied about in investing circles - from average true range to zero coupon bonds. There are three words, though, that if acknowledged and acted upon make all the difference between success and failure in investing. The three words are: “I don’t know.” These words are quite literally wonderful – full of wonder. And they hold the key for your investing success.
Let’s say you have $10,000 to invest. You have a world of opportunities in which the money can be invested. Do you buy Amazon (NASDAQ: AMZN) or Exxon (NYSE: XOM)? What about Deckers Outdoors (NASDAQ: DECK) or Dollar General (NYSE: DG)? Maybe you want to follow your own version of a Buffett rule and buy Berkshire Hathaway (NYSE: BRK-B). Remembering the sobering fact that you don’t know will help in multiple ways.
You don’t know what will go up and what will go down. The best you can do is make an educated guess based on all the information available. Knowing that you truly don’t know will help you be more stringent about ensuring that you have done your homework in gathering and analyzing pertinent information about the potential alternatives. For example, I think that Amazon is one of the most innovative companies on the planet, so my original investing premise was that its stellar stock appreciation will continue. However, admitting that I really don't know made me research the company further. After more analysis, my conclusion is that Amazon's price already reflects future growth that even it is unlikely to meet.
Because you don’t know, you will be more likely to spread the risk. Instead of putting the entire $10K in one stock, you might buy shares in all five companies. Selecting stocks in different sectors is Foolishly smart. I like to include companies with attractive PE ratios that pay dividends. Exxon Mobile matches this criteria well with a forward PE below 10 and a 2.2% dividend.
Deckers Outdoors is a great company with a beaten down stock that appears likely to rebound. If you knew for sure that Deckers would go up, putting every dime in DECK and letting it skyrocket makes sense. Since you don’t know for sure, having stop orders in place in case the stock tanks helps manage your risk. Stop orders were invented for people who don’t know. Using stop orders comes with its own uncertainty, however. You don't know if the stock will suddenly shoot up immediately after your stop hits. It happens.
Even if you make double-digit returns, you don’t know when the joyride will end. This lack of knowing will prompt you to regularly reassess your initial analysis. You won’t know with certainty when the ride will end, but you can know without a doubt that it will eventually end. Dollar General has enjoyed a terrific ride up over the past few months. Will it continue? I think it's likely to maintain positive momentum due to its growth strategy, but (here I go again) I don't know absolutely. Therefore, periodically reevaluating Dollar General's execution on its business growth plans is prudent.
Knowing that you don’t know will make you want to know more about what can be known. (I’ll pause while you digest the previous statement.) You will read magazines, research companies, and check out blogs like this one. You will be more likely to filter what you read and hear because you realize that as smart and savvy as the writers and speakers on television may be, they really don’t know everything either. Even the great investor Warren Buffett doesn't know everything, so you will want to thoroughly check out Berkshire Hathaway before buying. For instance, you might be a little surprised to discover how low Mr. Buffett's return on equity is (around 6.5%). Berkshire has many strengths, but I generally prefer to invest in stocks with double-digit ROE values.
Will following the “I Don’t Know” approach (i.e. doing your homework on the front end before investing, managing risk by diversification and stop orders, continually reevaluating decisions, and striving to learn more) make you a more successful investor? Yes. That’s one thing that I do know.
Motley Fool newsletter services recommend Amazon.com, and Berkshire Hathaway. The Motley Fool owns shares of Amazon.com, and Berkshire Hathaway. Keith Speights (www.keithspeights.com) has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.