Tuning out the noise in investing
One of the toughest things about investing is tuning out all the noise: information that is irrelevant, unreliable or downright misleading. The more you eliminate distractions, the better your investment decisions will be.
This is hard is because of there is so much economic, industry and company-specific information to follow and process. And that does not even touch on the hype, from investment themes that draw a bandwagon of popular support to hot stock tips designed to drive up prices. How do you tune all this out? One way is to clearly identify the information you need to make rational investment decisions, and then ignore everything else.
Here are six things worth focusing on when making investment decisions.
1. Focus on earnings, not price performance
Low bank rates and bond yields have helped drive people toward stocks in recent years, sending the market to new highs. The S&P 500 is up about 55 percent since the end of 2011, and that strong performance is drawing still more investors into the market.
The problem is, S&P 500 earnings are up only about 40 percent over that same period. For the market as a whole and for individual companies, you should be more focused on how earnings are performing, because that will drive future price performance.
2. Consider barriers to entry
So you found a company which has been delivering impressive earnings growth. That's great, but you have to remember that in any business, success attracts competition.
When you consider investing in a company, think about whether they have any unique advantages that would make it difficult for competitors to replicate what they do. Otherwise, imitators will spring up to take away some of the company's market share.
3. Recognize differing perspectives
When you have an investment idea, try to figure out whether other investors already know what you know. You probably won't have any special edge on information, so try to figure out why your perspective on a stock might differ from the popular consensus, because that is what creates opportunities.
4. Understand the sensitivity of inputs and outputs
A company's earnings are a function of its inputs and outputs -- what materials and resources are needed to make its products, and how much of those products it can sell.
So, in trying to figure out how a company's earnings will perform, you should know what costs their inputs are sensitive to, and whether those costs are under control. Similarly, you have to think about a company's markets and how much appetite they have to continue buying.
5. Set targets
Investing is largely about assigning value. There are plenty of great companies that are mediocre investments because their prices have already risen sharply. You not only need to understand a company's business, but you need to be able to assign specific buy and sell prices based on the value of that business, so you will know when to get in and when to get out.
6. Analyze your successes and failures
Developing a consistent process is one way to repeat your successes and avoid repeating your failures.
Not every investment works out, but if you tune out the noise to focus on the facts, you should be able to minimize your mistakes.
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