Stop Making Investing So Hard

Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Jason Zwieg’s book “Your Money and Your Brain” shows that our brains get more of a kick from “finding the next big winner” then from actually collecting money from a proven winner.

That "big winner" syndrome, so to speak, resonated with me. I couldn’t help but remember all the stocks that I had bought after searching and scouring as if I was a treasure hunter only to see them fall. In almost every scenario, as I looked back (and in the mirror), it turned out I was reaching—to put it kindly.

If we all were perfect investors we’d be like robots, void of emotion, only calculating data ... but that’s not real life—or real money. Let’s be honest with ourselves. Knowing that we are desperate for the "next big winner" can make us more successful (if less interesting) investors. I changed my mindset that day and I hope to change yours, for the better, as well.

You should decide (like I have sans "Zwieg"), to treat your investments as if you are managing someone else’s money for a company; even if investing isn't your full-time job. Therefore you need protocol, a set of buy and sell rules (which Zwieg recommends) you won't be a robot but this will help you from letting emotion get in the way in the “heat of the moment”.

Mastering your emotions will make you money -- a heck of a lot more then mastering math will. If a stock doesn't pass your "buy rules," you need to make it untouchable, as difficult as that may be. What I'm asking you to do is to create your own buy rules, following the rationale I'm about to lay out. Doing so, will help keep you from becoming a market victim; trying to decide what your plan is in the heat of the moment, is just too hard. Here are a few I've stuck with, that may help you too:

It All Starts With the Numbers

Everyone has different financial metrics that are important to them. I like companies that are growing and relatively cheap so I track revenue growth and price to earnings growth. Further, I like companies that have a strong competitive edge and good future prospects so  return on equity matters to me. If a company is good at keeping competitors from eating up its returns, it’s likely that it’s doing something special.

These metrics will help you screen companies that have good prospects, the companies you will need additional homework, but this is how you come up with a "short list". Having a "short list" based solely on numbers (not your favorite brand, etc.) is the first step to becoming a rational investor. While we'll get subjective later, now is the time for reason, for example, my search ranks the following companies pretty high.

<table> <tbody> <tr> <td><strong>Company Name</strong></td> <td><strong>Revenue Growth% (past five years)</strong></td> <td><strong>P/EG</strong></td> <td><strong>ROE</strong></td> </tr> <tr> <td><strong>Liquidity Services</strong> <span class="ticker" data-id="209081">(NASDAQ: <a href="">LQDT</a>)</span></td> <td>17.24%</td> <td>0.69</td> <td>26.24%</td> </tr> <tr> <td><strong>Deere</strong> <span class="ticker" data-id="203294">(NYSE: <a href="">DE</a>)</span></td> <td>8.47%</td> <td>0.98</td> <td>44.92%</td> </tr> <tr> <td><strong>Oracle</strong> <span class="ticker" data-id="204823">(NYSE: <a href="">ORCL</a>)</span></td> <td>15.58%</td> <td>0.94</td> <td>24.16%</td> </tr> <tr> <td><strong>O'Reilly Automotive</strong> <span class="ticker" data-id="204831">(NASDAQ: <a href="">ORLY</a>)</span></td> <td>20.45%</td> <td>1.14</td> <td>22.63%</td> </tr> <tr> <td><strong>Titan International</strong> <span class="ticker" data-id="206581">(NYSE: <a href="">TWI</a>)</span></td> <td>16.96%</td> <td>1.04</td> <td> <p>25.66%</p> </td> </tr> </tbody> </table>

Quick note:  I should mention that I value a company's return on equity and p/eg over revenue growth. While all three are important, not all sales are good or situationally appropriate. Separately, you'll never find a situation where earning a good return on equity signals a bad thing for a company.

Everybody Has to Grow

We’ve all bought a stock that has stayed in a range, seemingly forever; nothing is more maddening. For that reason, and due to the inherit risk in owning a stock, you should demand at least two long-term catalysts that will make the stock move drastically higher. This is where investing gets subjective. It can’t all be numbers!

You'll have to decide what the catalysts you look for are, but I think the following will be ideal for you. A company that

  1. is a small cap and is growing quickly while offering something few other competitors can at a high level
  2. is part of a long term bullish theme or
  3. is vastly misunderstood and therefore undervalued by the market.

That's right -- no turnaround stories or dividend plays for this guy. You're taking too much risk owning a stock for that. While all the companies listed have catalysts I could list, the best play is Deere, which (in my opinion) is both benefiting from a long-term agricultural bull market, and is also undervalued because the market, well, undervalues that bull. With 7 billion people to feed, going to 9 billion by 2025, and a rock solid company, you can't go wrong here.

Who’s Calling the Shots?

I'll keep this rule brief: You need to know who runs your company. Sounds simple, right? It's amazing how many investors overlook this aspect. While you'll never have a perfect feel on management, look for management that is innovative (no bean counters!) and tenured. If we can find a company where the founder is still running the show, even better.

On both these aspects, the obvious best choice of our short list for management is Oracle's Larry Ellison, who is both the founder and has led much of the companies innovation. It's hard to beat that combination.

Before you buy…

Finally, we need a company with staying power. One of the biggest pitfalls for most investors is being biased toward the stocks you own or want to buy. You’ve got to be very careful not to “write the story” for them, but rather let them prove themselves to you. Holding on to a company, you've fallen in love with after its investment thesis has changed will cost you dearly--don't do it, you're investingrealmoney after all.

For this reason, I want you to adopt my six words in investing: “Before You Buy, Write Down Why”.

That’s right. Write down (on paper) exactly why you’re buying this stock, why it’s going to go up, and exactly how the company makes money. Write it down and look it over as if you were going to send it to a board of directors for approval. This way, you'll know when the reasons you bought have changed or stayed the same. If they've stayed the same hold on to the stock regardless of price; the same is true of the opposite.

Finally you should look at your chosen stock and pull what I call a "Berkowitz".

"We spend a lot of time thinking about what could go wrong with a company -- whether it's a recession, stagflation, zooming interest rates or a dirty bomb going off. We try every which way to kill our best ideas. If we can't kill it, maybe we're on to something."-Bruce Berkowitz

I love that quote, so yes, before we buy, let's run our company through an Armageddon scenario. Why? People who don’t do this, sell when everyone else does, they become market victims. You need conviction in your soul to endure the emotional havoc a 30% single day decline can bring, "pulling a Berkowitz" helps.

If You Only Have One Rule

If you take only one rule from this article, please let it be this: never buy a stock just “for the dividends” or to “match the market”. You shouldn't buy a stock unless you feel it can outperform the market at least 2-1. Stop making it so hard!

If you want dividends, buy a dividend ETF. If you want to match the market, index. Let’s say you want to be in the aforementioned agriculture bull and you agree with me, if you can’t find a perfect stock I’d rather you just buy an ag ETF like Market Vectors Agribusiness Index ETF to ride the bull with me.

Investing is too hard, and buying stocks exposes you to risk, so don't throw your money around. The science behind solid investing lies in eliminating risks. Funds of all kind (and their diversity) do that; they won't go bankrupt, so that’s a huge risk off the table. When you buy a stock, you bring that risk back on the table. The possibility for market crushing rewards has to be there — otherwise, what is the point?

Stop Making Investing So Hard

Truthfully, if you were a close family member or a friend (since you’re a Fool, you practically are!), I’d tell you to invest in a few ETF’s or mutual funds with most of your capital. Then purchase a select few stocks that meet your buy list criteria. Leave the diversification to funds. You want to buy stock in companies you know intimately, which means they have to make it through your own version of a “stress test”. Doing so will help you master your temperament, and ultimately make more money.

mrrightside owns shares of Deere. The Motley Fool owns shares of Oracle. Motley Fool newsletter services recommend Liquidity Services. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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