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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