In an earlier article, I suggested that if you want to separate yourself from the investing herd, you need to work with constant diligence and passion, just as you would in any other profession. The most successful investors also follow a consistent pattern, day in and day out. To that end, I identified six fundamental principles that you need to follow if you want to effectively and intelligently allocate capital. We discussed the first three in part one:
- Principle No. 1: Have a sound investment philosophy.
- Principle No. 2: Develop a good search strategy.
- Principle No. 3: Know how to value a business and assess management quality.
These principles build on one another, so you can't effectively develop a good search strategy until you have a good investment philosophy, and so on. Once you've sought out and located several good candidates, and have properly placed a value on the business and quality of management, you can begin applying the remaining three.
Principle No. 4: Have the discipline to say no.
Price is what you pay, and value is what you get. Once you have identified a potential investment, and your data and reasoning lead you to conclude that you have a great business run by able and honest management, you still have to be willing to hold off if the price is not right. Amazon.com
In a case like this, be disciplined enough to walk away and search elsewhere. Always remember that any business is undervalued at one price, fairly valued at another, and overvalued at yet another. The intelligent investor's goal is to buy at the undervalued price, avoid at the fairly valued price, and sell at the overvalued price. Only by maintaining a very disciplined approach can this strategy be carried out effectively.
Principle No. 5: Be patient.
Principle No. 6: Have the courage to make a significant investment at the point of maximum pessimism.
The ability to make an investment during the most dire market conditions is the most difficult principle to follow. If you are not willing to look stupid in the short run, you're unlikely to be a successful investor in the long run.
Making an investment in a business during a downturn requires that you be disciplined, patient, and confident in your data and reasoning. In short, it requires a sound understanding of the five previous principles. Most importantly, you have to be able to ignore what everybody else is throwing at you.
You will be glad you did. Investments made during a company's turmoil will yield the best results. Buffett became one of the world's best investors by investing big during times of distress. Few people have the conviction to put nearly a third of their assets into a single business still drifting in the wake of a scandal. Yet that's exactly what Buffett did in the 1960s, when he put more than 30% of his partnership's assets into American Express
In summary ...
Successful investing requires that the enterprising investor maintain discipline, eliminate emotion, develop an intensive approach to investing, and always adhere to these six basic principles. Just so you don't forget:
- Have a sound investment philosophy.
- Develop a good search strategy.
- Know how to value a business and assess management quality.
- Have the discipline to say no.
- Be patient.
- Have the courage to make a significant investment at the point of maximum pessimism.
Follow these rules, and you are certain to become a successful -- and intelligent -- investor.
Fool contributor Sham Gad is the managing partner of the Gad Partners Funds, a value focused investment partnership based on the original Buffett Partnerships. He has no positions in the companies mentioned. Reach him at firstname.lastname@example.org. The Fool has a disclosure policy.