DIY Stock Picker

IMPORTANCE OF AN INVESTMENT PHILOSOPHY

IMPORTANCE OF AN INVESTMENT PHILOSOPHY

“Investment Philosophy” in simple terms means why you made a particular investment and the reasoning behind it. This is a very important concept and a must do before you pull the trigger to buy a company’s stock.

You should be able to explain in very simple terms why you want to make the purchase. You can give this reasoning to your middle school son or your friend (I prefer not to give to your wife as it may get shot down for the wrong reasons!)

This kind of reinforces your thought process. If you cannot give this simple explanation, it means you are making an emotional decision and not a rational one.

The following are some example templates that you could use:

  1. I want to purchase Company XYZ’s stock because it has a very low P/E and book value and it has been oversold. The market is overly worried about its potential whereas I think there is a potential for steady earnings in the long term.
  2. I want to purchase Company XYZ’s stock because it has consistent earnings and offers a good dividend with a low payout ratio (so the dividend is secure).
  3. I want to purchase Company XYZ’s stock because it is in a hot industry where there is a huge runway for growth and it is still priced reasonably in that it is available for a couple of times of its revenue.
  4. I want to purchase Company XYZ’s stock because there is a chance of a merger happening in the near future and there is room for enough arbitrage.
  5. I want to purchase Company XYZ’s stock because it has no long term debt, consistent earnings, buying back its shares and priced at an attractive multiple of its cash flow.

Also before you make the purchase also try to come up with an exit strategy. It could be as simple as follows:

  1. I will hold on to this stock until it reaches a certain book value.
  2. I will hold on to this stock until it no longer aligns with its fundamentals. It may have had a great run and is overvalued.
  3. I will hold on to this stock until such and such merger happens.
  4. I will hold on to this stock until it reaches a certain multiple of its cash flow.

I would encourage you to write down your investment philosophy and periodically review it. There may be times when the price of the stock may go down drastically or there may be too much noise around the company or you may be having buyer’s remorse. During these times, pull out your philosophy and read it with a calm mind. Does it still hold true? If yes, ignore the noise and carry on with your life, but if for some reasons, the fundamentals have changed, sell the stock and write lessons learned against your philosophy. This way you can evolve and refine your philosophy and keep getting better and better at making Stock market investments.