Know what your are Investing In

Always know the company you are Investing in

Not knowing what a company does before investing in it is very similar to going camping without packing extra underwear. You don't want to get caught with your pants down. "Circle of Competence" is the buzzword being thrown around.

Investing within your circle of competence is to understand what a company does before deciding to own a share of it. If you cant illustrate what a company does with a simple drawing or explain what it does to me before I finish my number twos, you probably don't understand it very well.

Without a thorough understanding of a company, you will not be able to understand

• How does it actually make money
• Is the business model sustainable in 5 to 10 years
• What are its strengths and weaknesses compared to the competition
• How capable is the management
• The current financial health of the company
• Know what returns to expect and when to sell the share

 If you are not willing to pay $5000 on a handbag that isn't made by prada/gucci/LV, don't throw away your money by investing in something that you do not understand based on hear say.

Some tips to improve your circle of competence

1. Spend some time reading other blogs and news
2. Start with something that interest you or a product that you use often
3. When researching a share, make some notes that you can refer back to
4. Practice explaining it to your friends/family

What Good Stocks Have In Common

How to find your next winner

For many people, finding the right stock is reading about it from the newspaper/analyst reports, or hearing about it from someone who made money off it. Think of it as a MANGO sale, if you heard about it from someone else, by the time you get to the shop you might have to rip the last piece off the sales person.

Warren Buffett has always looked for a few inherent strengths within the company he is look to invest in.

Companies that stand out from the crowd with unique products or services

If 10 companies sold the same product. Well, 9 of them must be stupid and 1 a genius. Either way, a price war is unavoidable and this leads to companies undercutting each other. There are many companies with unique products like Coca cola and Kraft. For some local examples. maybe Tiger Beer (which got bought over) and Singapore Press Holdings (which have little competition. If you think of bread, you think of Breadtalk. Macdonald's is the first to come to many when they think of fast food. These companies command high margins as they can pretty much charge whatever they want to consumers.

Low cost buyer and seller of commonly used products and services

These are companies that offer products that are used regardless of an economic boom or recession and do not have to spend alot of capital to redesign their products. You are have to eat and buy groceries during a recession, see the dentist and take public transport. (Think cold storage, Sheng Shiong, Q&M, SMRT) These companies operate with smaller margins but more than make up for it with volume of sales.

While I'm not asking you to purchase the above shares, think about why you invest in a company before you buy the stock. Does it have some kind of advantage over the competition.

Companies with a competitive advantage

This segment will require some financial knowledge which can be found under Education.
These companies with significant advantages (also know as economic moats)

1. Command higher margins as they do not have to engage in price competition
2. These companies consistent make a profit while managing to keep costs low consistently and avoid getting into debt
• Low % of expenses to gross profit <70% or thereabouts
• Little need for capital expenditure (CAPEX <50% of Net Profits)
• Little to no interest expense on loans (Interest expense to operating income <15%)
• Consistent upward trend in earnings, net profit margins(>20%) and earnings per share (EPS)
3. High cash flow generation with no debt
• Able to pay off total debt with annual earnings within 4 years
• Debt to equity ratio of less than 0.5 or low compared to the sector average
4. High Return on Shareholders Equity (ROE)
• ROE > 20%

With such companies, you would have no problem holding them for 10years plus, earning dividends yearly along with capital gains.