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How to Invest – Always Understand Any Company You Buy

Focus on your 'circle of competence'

   

How to Invest – Always Understand Any Company You Buy

e book 300ad How to Invest   Always Understand Any Company You BuyDo you have a tip on a great stock ? Are you tracking company with a great product that’s in demand? Do you have the “next Apple (NASDAQ:AAPL)” in your sights?

Having hot investing ideas is nice … but if you’re frugal like me, the first thing you want to know is what the risks are. After all, most businesses are very complex, and the risks aren’t obvious at first glance.

Remarkably, the most effective way to protect yourself from hidden costs is very simple: Don’t buy a company that you don’t understand. That ensures you won’t be surprised by some complex venture that winds up costing the company a bundle. This is a tip that is espoused even by the great Warren Buffett, who famously said of his investment company: “If we can’t find things within our circle of competence, we don’t expand the circle. We’ll wait.”

Yes, your “circle” is smaller than that of some Wall Street experts. You and I do not have access to fancy tools or insider connections like hedge fund managers do. But while that might limit our options, it does not mean we cannot invest if we stay within our comfort zone.

Despite the fact that I’m just a lowly journalist, I have made many profitable trades in the market simply by following the old writer’s adage “write what you know.” With my portfolio, I invest in what I know. And that has paid off big-time.

Invest in What You Know

Frugal investors should give that writer’s adage a turn of phrase, changing it instead to “invest in what you know.”

For writers, the phrase “write what you know” doesn’t mean make everything autobiographical. Obviously, good science fiction is written by folks who never have visited Mars. But I guarantee someone who flunked astronomy will have a hard time writing a good story about rocket ships and outer space.

For self-directed investors, “invest in what you know” means truly understanding how a company makes money and why it might succeed or fail. For instance, you don’t have to be a contractor or a real estate agent to buy homebuilder stocks — but you have to understand the finer points of the housing market, such as foreclosure trends or mortgage rates.

If you have common sense, there are a host of corporations with large but relatively straightforward businesses that are fair game. PepsiCo (NYSE:PEP) sells soft drinks and snack foods. J.C. Penney (NYSE:JCP) sells clothes and housewares. FedEx (NYSE:FDX) ships packages. Those are investments even rookie investors will be able to wrap their heads around.

The intention here is simply to ensure that you’ll know what you’re looking at when you start to dig into a potential investment’s profit and sales numbers. Because while The Frugal Investor’s Guide to Finding Great Stocks offers you tips about how to do research, you have to have context to make sense of the numbers. Otherwise, it’s all meaningless.

You Already Are an ‘Expert’

One final but very important note: Your experience and knowledge has great value.

Don’t ever fall into the trap of thinking otherwise. Because the sooner you realize you are indeed an “expert” in a few areas, the sooner you will succeed in the stock market.

Penny pinchers save money every day by changing their own brake pads or sewing their own curtains. As a frugal investor you can put your expertise to work in your portfolio the same way

Check out a complete list of Investing 101 articles by Jeff Reeves for more on learning how to invest and pick stocks.

Don’t want to keep clicking to read the whole series? Then download the complete series of Jeff’s educational articles for just 99 cents via his e-book “The Frugal Investor’s Guide to Finding Great Stocks: 11 Free Resources to Help Beginners Identify Fantastic Investments.”

You can also buy a printed copy of “The Frugal Investor’s Guide” for $15.10 via online publisher Lulu.


Article printed from InvestorPlace Media, http://investorplace.com/2012/03/how-to-invest-understand-stocks/.

©2014 InvestorPlace Media, LLC

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