Over the years, much has been written about Warren Buffett's two rules for investing. They are:
- Rule One: Never Lose Money
- Rule Two: Never Forget Rule One
That's great advice, but it's completely useless when it comes to daily decision-making about your investments. Today, I'm sharing some practical advice (and stock picks) you can actually use, and I only need one rule to do it. I'm certain Mr. Buffett would approve.
The One Rule: Make smart investments on unloved, risky stocks with fantastic long-term stories.
What it means
Sometimes the market crushes specific stocks, knocking their prices down from 52-week highs. Our job as investors is to sort through these stocks and find the ones to which the market has over-reacted. Ask yourself, "Has the outlook for the company actually changed?" Divorce yourself from stock price declines, Wall Street analyst calls, and the talking heads on various television channels. Just focus on the underlying company and its future prospects. If they're as sound as ever, then you may have a smart buying opportunity on what others deem to be a risky stock.
Now, let's jump straight into two stocks, why they're unloved, and my take on their long-term outlook.
Why it's unloved: Sandridge's bet on natural gas has not paid off due to persistently depressed prices. Despite a diversification into oil, the company carries a significant total debt load of almost $3 billion, which gives it a total debt-to-equity ratio of a very unhealthy 210%.
My take: Two years ago, I bet a chunk of my personal portfolio on natural gas, so I'm feeling Sandridge's pain; however, I generally don't like to see companies shift away from their previous focus after asset prices have already declined significantly. By divesting a large part of its assets in the Permian Basin, it could be mortgaging its future in order to survive right now. It’s hard to know, but I’m sure of one thing: I don’t like the debt situation, and this overall circumstance is just too murky to see through.
Overall, it seems as though there may good reason why investors think Sandridge isn't worth the risk, and at least at this point, I'm going to have to agree.
Next up, we have Cirrus Logic
Why it's unloved: Unloved may be a strong word for Cirrus, as it's up 150% over the past year; however, it's still down 15% versus the Nasdaq over the past three months, largely due to weak quarterly earnings and some concerns over its inclusion in future Apple
My take: I like Cirrus Logic over the long-term based on Motley Fool technology guru Eric Bleeker's analysis after his October interview with CEO Jason Rhode. In fact, I own it in my personal portfolio for the exact reasons mentioned in Eric's excellent article. The Apple threat is and was overblown, but that's not really our long-term story; it's what makes the stock risky in the short term and provides us with a buying opportunity.
The long-term bet is that Cirrus is making a vastly superior product at effective costs (hence its inclusion in Apple products.) If it's good enough for a very demanding Steve Jobs, it should be good enough for other smartphone players like Research In Motion
That's not to say Apple doesn't drop it from the next generation of iPad and iPhone, which would devastate the stock in the short term -- we simply don't know. But that's the essence of my one simple rule. Put a portion of your portfolio in companies with great long-term stories that others are calling risky. Some will fail in the short term, but the big winners will more than clean up the losers.
How you can get started right now
The key is to always be on the lookout for other risky stocks worth buying at great prices. That's the core of Warren Buffett's investment philosophy and one worth following. In fact, Motley Fool analysts have been stalking Buffett's buying activity and have identified in a new free report one "risky" health-care stock that Buffett's been quietly buying. Today, I invite you download this free report, The Health-Care Play That's Worth the Risk, at no cost to you – no credit card required. Get instant access to this free report by clicking here now.