To succeed in the stock market, one must reduce the noise and pick on the signals instead. It's crucial to pick great businesses, but how does one identify them?
Pat Dorsey, the founder of Dorsey Asset Management, has written a book called "The Five Rules For Successful Stock Investing", highlighting how one can move in the right direction to pick great stocks.
Dorsey is known for developing the economic moat ratings and the methodology behind the framework for analysing the competitive advantage for Morningstar. In his book, there are lots of insights. Here are some of them.
The five rules for successful stock investing
Dorsey believes that there must be an investment philosophy and a way of thinking about the world, the absence of which makes your journey challenging in the market. Thus, he recommends five rules which may act as a roadmap.
- Do your homework: "The most common mistake that investors make is failing to thoroughly investigate the stocks they purchase. Unless you know the business inside and out, you shouldn't buy the stock".
- Find economic moats: "Economic moats allow a relatively small number of companies to retain above-average levels of profitability for many years, and these companies are often the most superior long-term investments".
- Have a margin of safety: "Finding great companies is only half of the investment process; the other half is assessing what the company is worth. You can't just go out and pay whatever the market is asking for the stock because the market might be demanding too high a price. And if the price you pay is too high, your investment returns will likely be disappointing...the goal of any investor should be to buy stocks for less than they're really worth".
- Hold for the long haul: "Investing should be a long-term commitment because short-term trading means you're playing a loser's game. The costs really begin to add up—both the taxes and the brokerage costs—and create an almost insurmountable hurdle to good performance".
- Know when to sell: "Knowing when it's appropriate to bail out of a stock is at least as important as knowing when to buy one, yet we often sell our winners too early and hang on to our losers for too long... The key is to constantly monitor the companies you own rather than the stocks you own. It's far better to spend some time keeping up on the news surrounding your companies and the industries in which they function than it is to look at the stock price 20 times a day".
Simple yet profound insights like these drive Pat Dorsey's investing philosophy. And you can find more of them in this book.
Also read: Bill Ackman's guide to investing