3 Key Questions Successful Investors Ask

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:

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.