The Only Two Questions You Need to Ask

I'm going to make investing really easy for you.

Smash your calculator to bits. Rip your valuation tables to shreds. Laugh at your know-it-all accounting buddy. Successful investing really boils down to nailing the answers to the only two questions that matter.

Numbers, schmumbers
I don't mean to belittle the metrics. You'll often find me leaning on ratios such as price-to-earnings, interest coverage, and return on equity. Metrics are a great way to value a company relative to the market's other alternatives at the moment, but you're not going to unearth hidden treasure simply by crunching numbers.

Sorry to burst your bubble, Indiana Jones.

Everyone has access to the same numbers. The collective market is already grinding them in its perpetual weighing machine to arrive at the perfect balance between buyers and sellers.

That doesn't mean that superior investing is random or hopeless. You need to soak yourself in the bubble bath of clarity long enough to realize that all you need to do is answer the two questions: What can go right? What can go wrong?

That's it. It's not rocket science. If the market -- by spitting out a price -- is already accounting for everything that is known, it's what's unknown that will dictate that future of upticks and downticks.

What can go wrong?
Anyone who fails to approach a stock purchase without first assessing the worst-case scenario is doomed.

No one likes to think about the pitfalls. All stock purchases are optimistic, because no one buys long shares expecting the company to tank. Behind every steep loss, then, there is an investor who was blindsided.

I thought I was getting a bargain when I bought into Crocs (Nasdaq: CROX  ) after the stock fell over concerns about the inventory level raised in last year's third-quarter report. I figured that the blip was the result of international expansion and the widening product line.

Instead of weighing the implications, my inner optimist tagged the discounted shares as a market overreaction. This was supposed to be the next Nike (NYSE: NKE  ) , not the next faddish Heelys (Nasdaq: HLYS  ) . I dove in, buckling my seatbelt for the next leg down after the inventory concerns carried over into the holiday quarter.

I didn't see it coming, and now the market has scaled back its expectations.

Sirius (Nasdaq: SIRI  ) investors probably thought they struck gold when the satellite radio provider announced it would buy its rival in a merger of equals. They probably never banked on the deal being tied up in red tape for 13 months, all while losses mounted and dashboard alternatives accumulated. Despite healthy subscriber growth and narrower losses, Sirius shares are trading lower than they were before the merger was announced.

What can go right?
Rewards always taste sweeter when everyone is betting against you. I recommended Baidu.com (Nasdaq: BIDU  ) to Motley Fool Rule Breakers subscribers two years ago, at one-third of today's price.

Many argued that China's leading search engine was overvalued and vulnerable to competition. I saw it differently. The Chinese economy and Internet migration rates were growing too fast to ignore.

Locals also like their favorites. Am I surprised to see that Baidu has gained market share in that time, blowing past Wall Street's estimates during most of the subsequent quarters? No, because I dared to dream out loud about the upside. It was the bears donning blinders who were surprised.

Whether it's a company like Hansen Natural (Nasdaq: HANS  ) , daring to butt heads with beverage giants with its Monster energy drink, or the Web-based enterprise software delivery innovation of a Salesforce.com (NYSE: CRM  ) , it was those investors who mapped out successful scenarios who could justify paying up for the stock and turned connect-the-dots artwork into multibagger masterpieces.

Dreaming big
As part of the Rule Breakers team, my fellow analysts also look for companies with ridiculous upside potential. You're probably just like us, and you're welcome to prove me wrong over the next few weeks with a free 30-day trial subscription to the growth stock service.

Can we be accused of failing to fully grasp the negative surprises sometimes? Sure. I know that I've had my share of misses. Our scorecard is certainly not immune to pain. However, I feel better prepared than most investors to pick the next market winner because I'm already approaching stocks with the perfect pickup lines.

What can go right? What can go wrong? Figure out those two answers and go from there.

Longtime Fool contributor Rick Munarriz wonders why more investors don't know about the only two questions that matter. He's still holding onto his shares of Crocs. Baidu is a Rule Breakers recommendation. The Fool has a disclosure policy.


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