The mantra: Buy Low, Sell High
Basically the ‘secret’ of every successful investor. The problem that majority failed in the stock market is that they do the otherwise.
DON’T SELL IN PANIC
It's pretty simple, don't sell when there's a panic. This should become one of your cardinal rules. It's a rule you use in your everyday life. If you get sick do you lay down and die? No, you go see a doctor. If the stock market is panicking just remind yourself this is the speculator having his day, his bad day, and as long as you stay in for the long run you're going to be okay.
DON’T BUY IN GREED
Do not let greed convince you to buy. It will cloud your judgment and rule your emotions. We've already stated that you need to make decisions based on facts, not emotions. Just because a stock is suddenly cheap and available doesn't mean you should instantly buy it. You can certainly look into it, and do your research. But make sure you do your research and analyze the opportunity and make a scientific decision before you even spend a penny.
MAKE A PLAN AND STICK TO IT
Whether you following active or passive investing, ensure that you have a plan and then stick to it. You can create times for when you reflect and revise your plan. However, that should be done on a scheduled basis and not when there's a panic or a moment of greed. Make sure you stick to your plan. Don't spend more or less then you have laid out to do. And make sure that you write your plan down. When you write your plan down it gives more permanence to your plan and ensures that you're more likely to follow it. You can also rely on your plan to keep you calm when there's a moment of panic in the market. You won't be consumed by the immediate drama. When you refer to your plan you'll be reminded that the long-term is there and you will do well in the long-term.
What's the plan?
The answer lies in value investing! The father of value investing, Benjamin Graham had devised the simple investment strategy that anyone can use. He believed that if a stock fits into 5 simple criteria then it was an ideal stock for investment. Considering that many billionaires still continue to use his strategy in the present day and make a great deal of money doing so, it's a worthwhile strategy to follow. The criteria are as follows.
1. Price to Earnings Ratio
The price to earnings ratio has been considered one of the most commonly known investment indicators of value. It is frequently and commonly used by professionals as well as anyone who undertakes investing. The price to earnings ratio takes into account a stock's current price per share relative to its earnings per share. This can also be calculated as the market value per share relative to the earnings per share. This ratio will tell you what you have to spend to get a single dollar of a company's earnings. A high P/E ratio is considered a favorable prospect of purchase. However, a low P/E ratio could indicate that the company is undervalued. This is why no matter how popular this metric is, it should not be used alone to make your decision for buying a stock. It should instead be used in conjunction with the other four criteria.
2. An Attractive Dividend Yield
You should look for a company with an attractive dividend yield. That is to say, a company that has been paying out dividends for a long time. It's also important that the record is consistent as well as continuous. When a company is able to continue paying out dividends, it is clues for you to know that they are relatively stable. A company that has managed to survive Market fluctuations and the whims of the speculator is a stable company that is most likely going to keep functioning and growing driving profits into your investment. Some experts suggest you only consider companies that have been consistently and continuously paying dividends for at least 5 years. These companies such as utilities have an intrinsic staying power and make a great staple in your stock portfolio.
3. A price below book value
Graham’s philosophy is that he felt one should look for the best stock bargain possible. Looking for a stock that's priced at say two-thirds of its book value will most definitely create a margin of safety for you in case your calculations have had any mistakes. Buying at such a low price point allows you the opportunity to grow your earnings over time even if they grow slower than expected.
4. A price well below its previous high
In addition to a price below book value, you're also going to want to limit yourself to purchasing stocks that are priced well below their previous high. This is another method to allow you to create a substantial margin of safety which if not needed will result in a substantial growth of your investment and more money in your pocket.
5. An attractive price vs past earnings growth
To finally seal the deal, the fifth criterion is an attractive price in relation to the past earnings growth. This also will take a great deal of research looking back 7 to 10 years in the company's history.
MARGIN OF SAFETY
The margin of safety is the most important of all, his criteria only select the most stable and sound companies for you to purchase from, and they also quantify the price point at which you should be willing to purchase. All of these are conservative estimates which allowed for a generous amount of error in your calculations. Assuming you do have errors in your calculations while meeting all five of these criteria, your stock selection is still highly favorable to do well for you in the long run. It is absolutely imperative that you create a margin of safety for yourself and that you make decisions based on research, education, and science instead of emotions.