“Risk comes from not knowing what you are doing.” – Warren Buffett
Why is this? If you look at the stock market today it is flooded with a lot of fools, fools have money at their disposal but lack the proper knowledge to protect their money.
This is where the wave ride comes in the stock market, most of the “fools” since they don’t know what they are doing end up following the noise, they make their moves by riding the wave that carries a lot of junk. This is the reason a skilled investor will tell you that the only risk in the stock market is the noisy investor, the one who does not know what he is doing.
When I started investing in the stock market the biggest and most important part of the journey was acquiring the right education first, from there I found myself faced with an important decision. I had to decide whether I would be the day to day trader or a lifetime investor. I found trading to be boring and short term and knew right from that moment I was an investor, not a trader.
One of the reason I chose investing instead of trading was because I care more about value than instant cash, investing also held an upper hand for me because this meant I could care less about the day to day movement of the charts and the noise in the market generated by stock market fools.
Mine was to learn what I call the three angels for an investor, which are:
- Financial statements
- P/E Ratio
- Management Team
These angels are for me the most important things any potential investor has to know and understand, why are these angels important for the investor?
- Financial statements will tell you the profitability and growth of the company, there are three major statements to consider. The INCOME STATEMENT which tell you whether the business is making money or is running at a loss, then there is the BALANCE SHEET which tells you if the company has enough assets to generate income while covering their liabilities too. A company that has a higher liability column vs a lower asset column is a no go area. The last statement to look at is the CASH FLOW which determines how the management of the company makes use of the money at hand, the cash at hand should be directed towards value adding activities such as expansion of operations through capital expenditures with good Return On Investment.
- The P/E Ratio for others can be arguable but for me it is very important, this is a simple value that tells you if it is worthwhile to purchase the stock, the ratio will tell you if the stock is overvalued or undervalued. This is determined by dividing the current stock price by the Earnings Per Share (EPS) of the company. For the day to day trader who is obsessed about charts that a long term investor would really not worry about (an investor can only make use of charts to see the historical behaviour of the stock price), the P/E ratio would not make much of a difference, if you are going to buy a stock to hold for more than five years then it is important to know if you are paying money for good value. This is why the P/E ratio is very important.
- The Management of the company you intend to invest your money in is a very important factor to look at, if not the most important. These are the people responsible for healthy returns to the shareholders. It would be wise to consider for instance the importance of buying into a company that has a management team that has a culture of buying back its stock, this is because a company that buys back its stock decreases the outstanding stock thus creating a larger percentage ownership for each investor.
If you are an investor, the three angels are a must for you, Otherwise you might just find yourself riding the wave which is on its way to dump waste at the shore.
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