Investment Basics - Course 104 - What Matters and What Doesn't

By: Steve Bauer | Wed, Sep 22, 2010
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This is the fourth Course in a series of 38 called "Investment Basics" - created by Professor Steven Bauer, a retired university professor and still active asset manager and consultant / mentor.


 

Course 104 - What Matters and What Doesn't

Introduction

Different people have different notions of what stock investing is all about. Before we all go any further, I want to put things into focus and hopefully set you on the right path.


Investing Does Not Equal Trading

Your perception of stock investing may involve highly caffeine-ated, frantic traders sweating in front of a half dozen computer screens packed with information, while phones ring off the hook in the background. Or friends with little experience that claim great success in day trading.

You may (or may not) want to remove these images from your mind, (at least for this specific Course) because solid stock investing is not about active trading, having the fastest computers, or getting the most up-to-the-second information. Although some professionals make their living by creating a liquid market for stocks, actively "day trading" is not how most Investors go about making money.

Beyond having to expend an incredible amount of effort to track stocks on an hour-by-hour basis, active day traders have three powerful factors working against them.

First, aside from their time spent in front of the computer screen, trading commissions can rack up quickly, dramatically eroding returns.

Second, there are other trading costs in terms of the bid/ask spread, or the small spread between what buyers are bidding and sellers are asking at any moment. These more hidden frictional costs are typically, not understood and only a small fraction of the stock price, but they can add up to big bucks if incurred often enough.

Finally, frequent traders tend not to be tax efficient, and paying more taxes can greatly diminish returns. And, don't forget - keeping records for the IRS.

Just as someone can be a great racecar driver without being a mechanical engineer, you can be a great investor without having a clue about how the trades actually get executed in the market. How your orders flow from one computer system to the other is of little consequence.

Investing Wisely is like a chess game, where thought, patience, and the wisdom to peer into the future are rewarded.


Investing Means Owning Businesses

If the mechanics of actual trading mean little, what does matter? Do charts of stock prices hold the answers? I've said it once, and I'll say it again and again: When you buy stocks, you are buying ownership interests in companies. Stocks are not just pieces of paper to be traded.

So if you are buying businesses, it makes sense to think like a business owner. This means learning how to read financial statements, considering how companies actually make money, spotting trends, and figuring out which businesses have the best competitive positions. It also means coming up with appropriate prices to pay for the businesses you want to buy. Notice that none of this requires lightning-fast reflexes!

You should also buy stocks like you would any other large purchase: with lots of research, care, and the intention to hold as long as it makes sense. Some people will spend an entire weekend driving around to different stores to save $60 on a television, but they put hardly any thought into the thousands of dollars they could create for themselves by purchasing the right stocks (or avoiding the wrong ones). Again, investing is an intellectual exercise, but one that can have a large payoff.

Prof's. Guidance: You are taking this 38 week Course and will spend time learning. After this Course - you will spend time gaining experience. After gaining experience, you can be a profitable investor for many years to come, if you choose to do so. Go for it!


You Buy Stocks, Not the Market

We've all seen the prognosticators on television, predicting where the market is going to go in the future. One thing to remember when listening to these market premonitions is that stock investing is about buying individual stocks, not the market as a whole. If you pick the right stocks, you can make money no matter what the broader market does.

Prof's. Guidance: The above is true, but keep in mind - the General Stock Market influences the price of stock with a weighting or influence of over 60%. So being on the correct side of a bull or a bear market is very important. Right? I hope you learn this lesson well.

Another reason to heavily discount what the prognosticators say is that correctly predicting market movements is nearly impossible. Very few financial analysts / portfolio managers have done it consistently and accurately, over the years. There are simply too many moving parts, and too many unknowns. However, by limiting the field to individual businesses of interest, you can focus on what you can actually own while dramatically cutting down on the unknowns. You can save a lot of energy by simply tuning out market predictions.

We established in the previous lesson that stocks are volatile. Why is that? Does the value of any given business really change up to 50% year-to-year? (Imagine the chaos if the value of our homes changed this much!) The fact is, the General Stock Market tends to be a bit of an extremist in the short term, over-reacting to both good and bad news. I will talk more about this phenomenon later, but it is nevertheless a good fact to know when starting.


Competitive Positioning Is Most Important

Future profits drive stock prices over the long term, so it makes sense to focus on how a business is going to generate those future earnings. I suggest that - competitive positioning, or the ability of a business to keep competitors at bay, is the most important determining factor of future profits. Despite where the financial media may spend most of its energy - offering mis-information, competitive positioning is perhaps more important than the economic outlook, and much more important than the near-term flow of news that jostles stock prices, and even more important than management quality at a company.

It may be helpful to think of the investing process as if you were planning a trip across the ocean. You cannot do anything about the current weather or the tides (the current economic conditions). You can try to wait out bad weather that might sink your ship, but then you are also giving up time. And as we've already covered, time is a precious resource in investing.

The main thing you can control is what ship to board and who are the captain and crew. Think of the seaworthiness of a ship as the competitive positioning of a business, the experience of the captain and crew, and the horsepower of the engine as its cash flow. Some ships have thick, reinforced metal hulls, while others have rotting wood. Clearly, you would pick the ships that are the most seaworthy (with the best competitive positioning) and have the most horsepower (cash flow).

I will talk about exactly how to spot the best ships in later Courses.


The Bottom Line

It is very easy for new stock investors to get started on the wrong track by focusing only on the mechanics of trading or the overall direction of the market. It is also very easy for an old stock investor to be on the wrong track and not know it. To get yourself in the proper mind-set, tune out the noise and focus on studying individual businesses and their ability to create future profits. Study the ebb and flow of price movement and find the tools that work for you. Those tools are available but you must find them or finds someone who has both the tools and the experience of how to use them profitable.

In the coming Courses, we will begin to build the skills you will need to become a successful buyer of businesses.

Quiz 104
There is only one correct answer to each question.

  1. In general, the more frequently you trade:
    1. The higher your expected return from stock investing.
    2. The less you will pay in total trading commissions.
    3. The higher your tax bill.
  1. The stock market tends to:
    1. Be temperamental, over-reacting to near-term news.
    2. Be perfectly efficient, always valuing future cash flow accurately.
    3. Move with the phases of the moon.
  1. What will drive the price of a company's stock the most over the long term?
    1. Economic conditions over the next year.
    2. The future profits and cash flow a company can generate.
    3. The education level of top management.
  1. To be a successful stock investor, you need:
    1. To be able to think quickly, with fast reflexes.
    2. A powerful computer with up-to-the-minute information.
    3. Patience and the ability to think about future trends.
  1. What should you pay the most attention to?
    1. Charts of stock prices.
    2. A company's competitive positioning.
    3. The predicted movement of the overall stock market.

Thanks for attending class this week - and - don't put off doing some extra homework (using Google - for information and answers to your questions) and perhaps sharing with the Prof. your questions and concerns.

 


Investment Basics (a 38 Week - Comprehensive Course)
By: Professor Steven Bauer

Text: Google has the answers to most all of your questions, after exploring Google if you still have thoughts or questions my Email is open 24/7.

Each week you will receive your Course Materials. There will be two kinds of highlights: a) Prof's Guidance, and b) Italic within the text material. You should consider printing the Course Materials and making notes of those areas of questions and perhaps the highlights and go to Google to see what is available to supplement those highlights. I'm here to help.

Freshman Year

Course 101 - Stock Versus Other Investments
Course 102 - The Magic of Compounding
Course 103 - Investing for the Long Run
Course 104 - What Matters & What Doesn't
Course 105 - The Purpose of a Company
Course 106 - Gathering Information
Course 107 - Introduction to Financial Statements
Course 108 - Learn the Lingo & Some Basic Ratios

Sophomore Year

Course 201 - Stocks & Taxes
Course 202 - Using Financial Services Wisely
Course 203 - Understanding the News xxx
Course 204 - Start Thinking Like an Analyst
Course 205 - Economic Moats
Course 206 - More on Competitive Positioning
Course 207 - Weighting Management Quality

Junor Year

Course 301 - The Income Statement
Course 302 - The Balance Sheet
Course 303 - The Statement of Cash Flows
Course 304 - Interpreting the Numbers
Course 305 - Quantifying Competitive Advantages

Senor Year

Course 401 - Understanding Value
Course 402 - Using Ratios and Multiples
Course 403 - Introduction to Discounted Cash Flow
Course 404 - Putting OCF into Action
Course 405 - The Fat-Pitch Strategy
Course 406 - Using Morningstar as a Reference
Course 407 - Psychology and Investing
Course 408 - The Case for Dividends
Course 409 - The Dividend Drill

Graduate School

Course 501 - Constructing a Portfolio
Course 502 - Introduction to Options
Course 503 - Unconventional Equities
Course 504 - Wise Analysts: Benjamin Graham
Course 505 - Wise Analysts: Philip Fisher
Course 506 - Wise Analysts: Warren Buffett
Course 507 - Wise Analysts: Peter Lynch
Course 508 - Wise Analysts: Others
Course 509 - 20 Stock & Investing Tips

This Completes the List of Courses.

Wishing you a wonderful learning experience and the continued desire to grow your knowledge. Education is an essential part of living wisely and the experiences of life, I hope you make it fun.

Learning how to consistently profit in the Stock Market, in good times and in not so good times requires time and unfortunately mistakes which are called losses. Why not be profitable while you are learning? Let me know if I can help.

 


 

Author: Steve Bauer

Steven H. Bauer, Ph.D.

Steve Bauer

Steve has several degrees, i.e. post graduate degrees and doctorate and a great deal of (too much) continued education. For seven years, he did a stent as a University Professor of Finance and Economics.

He owned a privately held asset management firm and managed individual investor and corporate accounts as a Registered Investment Advisor - for over 40 years.

Professionally he is a financial analyst and private asset manager / consultant / mentor.

Steve can be reach at senorstevedrmx@yahoo.com

Copyright © 2010-2011 Steven H. Bauer, Ph.D.

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