On buying Stocks - Shares

Overconfidence
Several psychological studies have pointed out that errors in judgment occur because people in general are overconfident. Ask a large sample of people how many believe their skills at driving a car are above average,and an overwhelming majority will say they are excellent drivers.Another example: When asked, doctors believe they can diagnose pneumonia with 90 percent confidence when in fact they are right only 50 percent of the time.

I came to the psychology of misjudgment almost against my will; I rejected it until I realized my attitude was costing me a lot of money.
CHARLIE MUNGER, 1995

Investors have the following characteristics:
• True investors are calm.
• True investors are patient.
• True investors are rational.

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Ben Graham, as we know, fiercely urged his students to learn the basic difference between an investor and a speculator. The speculator, he said,tries to anticipate and profit from price changes; the investor seeks only to acquire companies at reasonable prices. Then he explained further:The successful investor is often the person who has achieved a certain temperament—calm, patient, rational. Speculators have the opposite temperament: anxious, impatient, irrational. Their worst enemy is not the stock market, but themselves. They may well have superior abilities in mathematics, finance, and accounting, but if they cannot master their emotions, they are ill suited to profit from the investment process.

Success in investing doesn’t correlate with IQ once you’re above the level of 125. Once you have ordinary intelligence,what you need is the temperament to control the urges that get other people into trouble in investing.
WARREN BUFFETT, 1999

It is a complex, puzzling, intriguing study. Few aspects of human existence are more emotion-laden than our relationship to money. And the two emotions that drive decisions most profoundly are fear and greed. Motivated by fear or greed, or both, investors frequently buy or sell stocks at foolish prices, far above or below a company’s intrinsic value. To say this another way, investor sentiment has a more pronounced impact on stock prices than a company’s fundamentals.

To make his point, Buffett asks us to imagine what happens if you buy a $1 investment that doubles in price each year. If you sell the investment at the end of the first year, you would have a net gain of $.66(assuming you’re in the 34 percent tax bracket). Now you reinvest the$1.66, and it doubles in value by year-end. If the investment continues to double each year, and you continue to sell, pay the tax, and reinvest the proceeds, at the end of twenty years you would have a net gain of$25,200 after paying taxes of $13,000. If, on the other hand, you purchased a $1 investment that doubled each year and never sold it until the end of twenty years, you would gain $692,000 after paying taxes of approximately$356,000.

Focus investing is necessarily a long-term approach to investing. If we were to ask Buffett what he considers an ideal holding period, he would answer “forever”—so long as the company continues to generate above average economics and management allocates the earnings of the company in a rational manner. “Inactivity strikes us as intelligent behavior,”he explains.

As a general rule of thumb, we should aim for a turnover rate between20 and 10 percent, which means holding the stock for some where between five and ten years.

You can see why Buffett says the ideal portfolio should contain no more than ten stocks, if each is to receive 10 percent. Yet focus investing is not a simple matter of finding ten good stocks and dividing your investment pool equally among them. Even though all the stocks in a focus portfolio are high-probability events, some will inevitably be higher than others, and they should be allocated a greater proportion of the investment.Blackjack players understand this intuitively: When the odds are strongly in your favor, put down a big bet.

THE FOCUS INVESTOR’S GOLDEN RULES
1. Concentrate your investments in outstanding companies run by strong management.
2. Limit yourself to the number of companies you can truly understand. Ten to twenty is good, more than twenty is asking for trouble.
3. Pick the very best of your good companies, and put the bulk of your investment there.
4. Think long-term: five to ten years, minimum.
5. Volatility happens. Carry on.

“We just focus on a few outstanding companies. We’re focus investors.”
WARREN BUFFETT, 1994

“The market, like the Lord, helps those who help themselves,” says Buffett. “But unlike the Lord, the market does not forgive those who know not what they do.”

Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised.
WARREN BUFFETT, 1988

few timeless financial principles:
• Focus on return on equity, not earnings per share.
• Calculate “owner earnings” to get a true reflection of value.
• Look for companies with high profit margins.
• For every dollar retained, has the company created at least a dollar of market value?

Warren Buffett gives us some valuable tips:33
• “Beware of companies displaying weak accounting.” In particular,he cautions us to watch out for companies that do not expense stock options. It’s an obvious red f lag that other less obvious maneuvers are also present.
• Another red f lag: “unintelligible footnotes.” If you can’t understand them, he says, don’t assume it’s your shortcoming; it’s a favored tool for hiding something management doesn’t want you to know.
• “Be suspicious of companies that trumpet earnings projections and growth expectations.” No one can know the future, and any CEO who claims to do so is not worthy of your trust.

Expand your reading horizons. Be alert for articles in news papers and financial magazines about the company you are interested in and about its industry in general. Read what the company’s executives have to say and what others say about them. If you notice that the chairman recently made a speech or presentation, get a copy from the investor relations department and study it carefully. Make use of the company’s web pages for up-to-the-minute information. In every way you can think of, raise your antennae. The more you develop the habit of staying alert for information, the easier the process will become.