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Source: Flickr user Roberto Zingales.
During my final semester of college, I took a course in Zen Buddhism. I didn't know much about Zen or Buddhism at the time, and I don't know much now. But a few of the ideas stuck with me, such as the practice of studying koans. A koan is a short story, dialogue or phrase, often enigmatic or paradoxical, that is meant to produce doubt, followed by greater understanding and insight. I like the idea of koans, and I have one that applies to selecting stocks. It's simple, but I find it unlocks my personal common sense.
So here's my koan for investing enlightenment:
If a friend or neighbor approached you with the opportunity to purchase a minority interest in a local business -- say, a car dealership, restaurant, factory, or Web start-up -- what would you need to know? Now what if your friend ran a publicly traded company?
I find that this line of thought naturally brings me to all the right questions about a stock. Instead of thinking of it as a large, unrelatable entity that trades electronically every second, I think of it as a local business. And, by using that mind-set, I'm able to ask everything I need to know:
- Do you understand what the business does?
- Are the people running the business honest and talented?
- Does the business serve a useful purpose, generate a good profit, and please customers?
- Is the business sustainable? Can it grow? Does it have a competitive advantage?
- Is the price of the business reasonable relative to the potential profits you expect it to achieve?
Those are just common-sense questions that almost anyone could come up with, even without any investing training. But to ask them, you need to have a business owner's mind-set, which is hopefully what my investing koan helps you develop -- it has certainly helped me.
And, of course, if you bought a share in a local business, would you try to flip your ownership after a few months or quarters? Not likely; you'd be committed to holding for years or even decades.
