There are three extremely important questions that successful investors ask of any potential investment. The answers to those questions drive their decisions as to where they'll deploy their capital. Ultimately, the people who answer them the best become the top tier among investors. If you want to join that cadre, you'll need to learn those questions and how to answer them.

Fortunately, the questions are pretty easy to ask. And even better, at least one of them is easy to answer. Those all-important queries are:

  • What is this investment really worth?
  • Where is the market pricing it? (This is the easy one. Just look up a stock price.)
  • Why is there a difference?

That's really it
Boiled down to its essence, that's really all you need to know to make investing decisions. When all is said and done, if there's a difference between your opinion and the market's, at least one of you is wrong. If your analysis is correct, then you can earn excess profit by buying undervalued or short-selling overvalued stocks and simply waiting for the market to catch up.

If you're wrong, on the other hand, your investing decisions can backfire and cost you money. That's why that third question (Why is there a difference?) is so very important. It's not enough to simply come up with a different value than Wall Street has -- there's got to be a real reason to believe you're right to make it worth investing your money.

The easiest way to figure out what you think a company is worth is to use a valuation method like the discounted cash flow model discussed here. And with a little online research, it's not hard to find news stories explaining the market's most recent reactions to nearly any company.

Put it all together
With answers to the what, where, and why questions, you can start to make decent decisions about potential investments. A chart like this really puts it into perspective:


What Is It Worth?

Where Is the Market Pricing It?

Why Is There a Difference?

Wal-Mart (NYSE: WMT)



Concerns over declining same-store sales.

Cisco Systems (Nasdaq: CSCO)



Optimism over its new dividend policy and the resulting potential for financial discipline.

Verizon (NYSE: VZ)



Recent quarterly net loss, questions about cash flow post-Frontier spin-off.

Abbott Laboratories (NYSE: ABT)



Potential of its new dissolving stent to be a revolutionary medical device.

Kraft Foods (NYSE: KFT)



Hope for faster growth driven by its recent Cadbury acquisition.

Teva Pharmaceuticals (Nasdaq: TEVA)



Favorable recent court ruling on Copaxone, a large moneymaker for the company.

Emerson Electric (NYSE: EMR)



Recent 15% increase in orders.

Source: Capital IQ, a division of Standard & Poor's, as of Sept. 28. Stock value based on author's calculations.

For instance, it's pretty straightforward to see that the market's pessimism about Wal-Mart and Verizon is driven by recent operational concerns. If you're considering an investment in either company, you'll need to figure out whether they can get past those issues or if they'll result in permanent weakness.

On the flip side, you'll want to figure out whether Kraft can really successfully integrate Cadbury to leverage its potential and justify that premium price. Likewise, the optimism over Abbott and Teva may wind up being short-lived, as new products rarely live up to their hype and court decisions can be overturned on appeal.

And while Cisco's long-awaited dividend really is good news, the expected yield in the 1% to 2% range isn't much to write home about. In fact, it may not be enough of an incentive for Cisco to embrace the financial discipline that often enables solid dividend payers to perform well.

Which leaves Emerson and its recent growth-fueled pop. If that growth isn't a one-time fluke but instead is a sign that an economic recovery is finally gaining real traction, then the market's optimism could well be justified by its future prospects.

You can do it
When you ask -- and answer -- those three key questions (what, where, and why), you start to think like the world's top-tier investors. And that's your first step toward joining their cadre.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article. Wal-Mart is a Motley Fool Inside Value pick. Emerson Electric is a Motley Fool Income Investor pick. The Fool has a bull call spread position on Cisco Systems. The Fool owns shares of Teva Pharmaceutical and Wal-Mart. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.