What we can learnt from this market downturn

Image via Wikipedia Hope everyone have taken a lesson from this market downturn.

The Key takeaway :-
1) Diversify your investment. Don't put all into 1 or 2 stocks. Why risk it all on 1 or 2 stocks you can't even control. The management can do stupid things and its beyond your control. Whoever tells you to concentrate your investment and get rich? Warren Buffett? But he did mentioned that when he buys into a company, the first objective is to gain control and if not, he will get a significant stake enough to exercise pressure on the management. So, he had eliminated the factor that we small investors can't - direct/indirect influence on the management thru' his significant holdings.

2) Don't speculate, don't do short-term trading... but do monitor your investment at least monthly and rebalance quarterly or less frequently as necessary. In effect, this forces you to sell stocks that have run very high and buy into companies or assets that are underperforming but with potential to gain.

3) Please go and attend a course on understanding financial statements and buy some management books to read. Try to understand the management considerations of CEOs and you will know whether the company is operating good or not. Also, read up on management strategy ... at least try to understand what makes up competitive advantage, whether it is sustainable.

4) Debt level - this one is a killer for all companies (big or small). It is leverage and when times are good, it will be performing. But when times are bad, it will be disastrous.. So, monitor this one... In good times, when u see debt level too high... u will have to start thinking about what happens if the company cannot service or refinance its debt. Look at its interest cover, debt to equity ratio. Look at the annual cashflow and see whether the company is expending a significant of it on debt.

To Diversify or Not?

Image by Getty Images via Daylife I have been emphasizing the need to diversify your investments and not to concentrate most of it on just one single investment.

Yes, there will be investors who quote wisdom from warrent buffett or other stock gurus on the merits of concentrated investment and knowing your investment real well. That diversification is actually an excuse for ignorance.

But how many of these so called amateur investors think they are really in the class of the gurus? Unless they have proven themselves using a diversified portfolio that they have a knack for picking good companies (in which case, the overall stock portfolio would rise in value as well), they should not attempt to do concentrated investment.

Also, there have been numerous studies by private banks that a lot of entrepreneurs and CEOs have a bulk of their wealth tied to the fortunes of their companies (in the form of shares & options). As can be seen during the past few crisis, a concentrated holding (even for CEOs and chairman who knows their company and industry inside out) could not prevent the erosion of their wealth. In some cases, the company going bust (some internet companies, some banks) have allowed their employees to go from millionaires to zero-aire.

So, before you start having this fantasy that you are in the league of the investment gurus, please validate that statement first. Are you in that league yet?

For myself, I admit I'm not in the league of the gurus and to know I am not and to implement a safer risk-managed investment strategy will lead me to multiply my investment portfolio slowly but steadily.

Warren Buffett's Investing Checklist

Image by Getty Images via Daylife

Warren Buffett's Investing Questions

Before Warren Buffett invests a dime, he asks:

• Is the company in an industry with good economics? That is, is it not in an industry competing on price?
  
  
• Does the company have a consumer monopoly or brand name that commands loyalty?
  
  
• Can anyone with an abundance of resources compete successfully with the company?
  
  
• Are the earnings on an upward trend with good and consistent profit margins?
  
  
• Is the debt-to-equity ratio low, or is the earnings-to-debt ratio high? Can the company repay debt even in years when earnings are lower than average?
  
  
• Does the company have high and consistent returns on invested capital?
  
  
• Does the company retain earnings for growth?
  
  
• Does the business have high maintenance cost of operations, high capital expenditure or investment cash outflow? (If so, that's not good.)
  
  
• Does the company reinvest earnings in good business opportunities? Does management have a good track record of profiting from these investments?
  
  
• Is the company free to adjust prices for inflation?

In short, he makes companies jump through a lot of hoops before he considers putting them in his portfolio.

Source : InvestmentU