Many experts would argue that the hardest aspect of investing is selecting the right stocks. I don't believe that to be true. Great businesses are all around us, but the real challenge is in building enough conviction to hold them over the only term that counts: the long term.
Your success as an investor has less to do with your ability to find the little-known stock that's about to blow up, and more to do with your psychological fortitude to hold on to great businesses through the ups and downs.
Below are three ways to ensure you're buying quality companies and building a strong sense of conviction.
Do the research
We all know the importance of doing your homework before buying stocks, but this is still an area where lots of investors cut corners. This is mainly because it's not easy, and sometimes downright tedious.
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But that can be used to your advantage. By thoroughly researching companies, you're more likely to identify competitive edges that the market is missing as well as build confidence in the business to hold through corrections.
Stock research centers around fundamental analysis. This is the processes of reviewing a company's financials to determine if it currently trades below its "fair value." It involves studying the company's balance sheet to gauge its overall financial health (i.e., more assets than liabilities, enough cash to pay its short-term debt obligations, etc.) as well as diving into how the business produces profits (if at all).
For a deeper dive into fundamental analysis and stock research, see the article "How to Research Stocks."
The other side of the research coin is qualitative analysis, where investors analyze aspects of the business such as:
- Management team/founders
- Customer reviews
- Net promoter scores
- Glassdoor reviews
You can even get creative with a "boots-on-the-ground" approach, such as touring a manufacturing facility or attending a company conference.
Your understanding of the company is the foundation of conviction. The more familiar you are with quality businesses, the more confidence you'll have in their execution.
Invest in what you know
Peter Lynch, the famous manager of the Fidelity Magellan Fund, wrote in his book Beating the Street:
Your investor's edge is not something you get from Wall Street experts. It's something you already have. You can outperform the experts if you use your edge by investing in companies or industries you already understand.
Assume for a moment you work as a manager for a beverage distribution company with extensive knowledge of that industry and its countless vendors and suppliers.
Doesn't it make sense to look for opportunities to invest within the industry you have dedicated years of your life to understanding? Lynch advocated that doing so gives you a real advantage over even institutional investors.
This certainly doesn't mean that you have to exclusively invest in companies within your area of expertise, but from a research perspective, it makes things much easier.
Buy companies you believe in
Motley Fool co-founder David Gardner has long said to "make your portfolio reflect your best vision for our future."
In fact, it's the first principle in the The Motley Fool's service.
While it sounds nice, this principle is more than just investing in ethical companies. Notice the key word being your best vision for our future. As an investor you get to vote on the future of the world with your dollars.
By allocating to companies you believe are creating a better society and planet for future generations, you're not only supporting the success of those businesses but also building incredible conviction in them simultaneously.
When you invest in a company like that, you'll find it hard to sell. Obviously if the fundamentals of the business deteriorate, you should allocate your money elsewhere, but believing in a company's mission is a powerful way of holding on to it for years or even decades.
The "best stocks" are the ones you never want to sell
There are quality companies all around us. Yes, finding that under-the-radar stock that's going to deliver 100x returns is very difficult. But there are plenty of returns out there for investors who simply buy quality businesses and hold them long enough to compound.
That "holding" is actually the hardest part. But you can make it easier on yourself by doing adequate research to understand the business, selecting companies or industries about which you have prior knowledge, and investing in businesses building toward a future you are excited about.
