Author Dave Van Knapp
EXCERPT FROM CHAPTER A-3: THE THREE STEPS TO SENSIBLE
STOCK INVESTING
Sensible Stock Investing has three basic elements:
These elements are interdependent. They overlap and operate simultaneously.
Let’s take a brief tour of these three elements now. Then in the remainder of the
book, we will explore them in detail and demonstrate how they will guide your
Sensible Stock Investing decisions.
Pick the Right Companies
The first element in Sensible Stock Investing is to pick the right companies. A
share of stock, after all, is a share in the ownership of a company. So when you
purchase a share of stock, you are buying into the future performance and
fortunes of the company. Naturally, you want to own superior companies with
superior futures.
Remember your objective: to build wealth at a pace faster than the market’s pace.
As a generalization that is good enough for now, stock prices for the most part
track the fortunes of the companies they represent. So the idea is to find
companies which will not only build their financial value, but which will do it
faster than the average company.
Of course, nothing in investing is guaranteed. The stock market’s day-to-day
vagaries can cause stock prices to become quite detached from the value inherent
in their underlying companies. Thus, no matter how well you select companies,
there is always an unavoidable element of market risk—the risk inherent in the
stock market itself. So it is imperative that you do what you can to tilt the playing
field in your favor. The first step in gaining this advantage is to identify truly
superior companies. How to do this is the subject of Part C of this book.
Pick the Right Price
The second move for the Sensible Stock Investor will stack the odds even more
in your favor. This is to determine an acceptable—or better still, an obviously
advantageous—price to pay for every stock that you buy.
The assessment of stock prices is referred to as “valuation.” The underlying idea
is that there is such a thing as a “fair” price for a stock, or that a company’s stock
has a certain “inherent value,” which market participants will generally agree
upon over time. If today’s price of the stock has become detached from its “fair”
price, then history suggests that, over time, the stock will gravitate toward that
fair price. So another way to look at this step is that you are trying to determine
the direction that the stock’s price is likely to go in the future.
Naturally, the direction we are interested in is up. Since stock prices vary daily,
are traded on an open market, and involve the buy and sell decisions of hundreds
of thousands of people using who-knows-what approaches, common sense
suggests that valuing stocks involves an inexact appraisal process of one kind or
another. Stock valuation, in fact, has many similarities to home appraisals. If you’
ve ever had a home appraised, you know that the exercise involves comparisons
to “similar” properties and the use of imprecise factors (such as the comparative
quality of materials used in the homes). Whether an appraisal is of a home, a
piece of heirloom jewelry, a used car, or a stock, the process is part art, part
science, and part luck. There are different ways to go about appraising anything.
Thus, reasonable minds often differ when appraising what a stock is worth. That’s
why stocks are traded—each party thinks he or she is getting the better end of
the deal. We offer a sensible approach that comes at the problem from a variety
of angles, avoids duplication, is relatively easy to compute, and weighs
information intelligently—all to put you on the right side of the deal more often
than not.
Putting these first two elements of Sensible Stock Investing together—picking
the best companies and picking good prices to pay for them—yields the
following fundamental tenet of our approach: If you purchase stocks of superior
companies at prices that are, for whatever reason, “low,” the market’s long-range
tendency to move stock prices in the direction of company performance will
reward you with better returns than the market averages.
You will beat the market.
STOCK INVESTING
Sensible Stock Investing has three basic elements:
- Pick the right companies.
- Pick the right price to pay for stock in those companies.
- Manage your portfolio intelligently.
These elements are interdependent. They overlap and operate simultaneously.
Let’s take a brief tour of these three elements now. Then in the remainder of the
book, we will explore them in detail and demonstrate how they will guide your
Sensible Stock Investing decisions.
Pick the Right Companies
The first element in Sensible Stock Investing is to pick the right companies. A
share of stock, after all, is a share in the ownership of a company. So when you
purchase a share of stock, you are buying into the future performance and
fortunes of the company. Naturally, you want to own superior companies with
superior futures.
Remember your objective: to build wealth at a pace faster than the market’s pace.
As a generalization that is good enough for now, stock prices for the most part
track the fortunes of the companies they represent. So the idea is to find
companies which will not only build their financial value, but which will do it
faster than the average company.
Of course, nothing in investing is guaranteed. The stock market’s day-to-day
vagaries can cause stock prices to become quite detached from the value inherent
in their underlying companies. Thus, no matter how well you select companies,
there is always an unavoidable element of market risk—the risk inherent in the
stock market itself. So it is imperative that you do what you can to tilt the playing
field in your favor. The first step in gaining this advantage is to identify truly
superior companies. How to do this is the subject of Part C of this book.
Pick the Right Price
The second move for the Sensible Stock Investor will stack the odds even more
in your favor. This is to determine an acceptable—or better still, an obviously
advantageous—price to pay for every stock that you buy.
The assessment of stock prices is referred to as “valuation.” The underlying idea
is that there is such a thing as a “fair” price for a stock, or that a company’s stock
has a certain “inherent value,” which market participants will generally agree
upon over time. If today’s price of the stock has become detached from its “fair”
price, then history suggests that, over time, the stock will gravitate toward that
fair price. So another way to look at this step is that you are trying to determine
the direction that the stock’s price is likely to go in the future.
Naturally, the direction we are interested in is up. Since stock prices vary daily,
are traded on an open market, and involve the buy and sell decisions of hundreds
of thousands of people using who-knows-what approaches, common sense
suggests that valuing stocks involves an inexact appraisal process of one kind or
another. Stock valuation, in fact, has many similarities to home appraisals. If you’
ve ever had a home appraised, you know that the exercise involves comparisons
to “similar” properties and the use of imprecise factors (such as the comparative
quality of materials used in the homes). Whether an appraisal is of a home, a
piece of heirloom jewelry, a used car, or a stock, the process is part art, part
science, and part luck. There are different ways to go about appraising anything.
Thus, reasonable minds often differ when appraising what a stock is worth. That’s
why stocks are traded—each party thinks he or she is getting the better end of
the deal. We offer a sensible approach that comes at the problem from a variety
of angles, avoids duplication, is relatively easy to compute, and weighs
information intelligently—all to put you on the right side of the deal more often
than not.
Putting these first two elements of Sensible Stock Investing together—picking
the best companies and picking good prices to pay for them—yields the
following fundamental tenet of our approach: If you purchase stocks of superior
companies at prices that are, for whatever reason, “low,” the market’s long-range
tendency to move stock prices in the direction of company performance will
reward you with better returns than the market averages.
You will beat the market.
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