Common Sense Investing

by Lance Spicer

“Doesn’t everybody use common sense when they invest?” The simple answer is few people do in reality. In fact many novice investors do the exact opposite.

They use their emotions or gut feeling to decide which investment to put money in. Some, even experienced investors, get caught up in hearsay, or “hot tips”.

Unfortunately, greed and anxiety run off with their common sense and it rarely makes a re-appearance…. until all their money is gone anyway. Now, I’m not just talking about mistakes made by buying the wrong shares, although that is a common occurrence and we’ll talk about that a bit later, but all the weird and wonderful schemes that people think will make them rich.

Schemes such as the ones where people get paid between 5% and 20% per month. Often called trading programs, these schemes are nothing but scams and ponzi schemes that are more urban myth than actual investment. Sure, some people do get paid, for a while, but the scheme soon stumbles and the whole thing collapses, although some schemes have lasted a few years, one that comes to mind was in Queensland, the Wattle Group, and it lasted for over six years.

My advice is to stay away from these things, they are promoted by people who earn a high commission from your participation and quite often the person promoting the scheme doesn’t know it’s a scam either, that’s how convincing they can be. I have seen some so elaborate and sophisticated that it had bankers and professional investors fooled. You’ve been warned, stay away.

When it comes to the stock market, being fooled into parting with your hard earned money can be almost as easy as being lured into some elaborate scam. The worst offenders here are inexperienced brokers and the venerable “hot tips” from friends and associates.

You shouldn’t depend on your broker for all the answers, they will all too often let you down. If your broker was such an “all-seeing genius”, what’s he or she doing turning up for work each day – they should be lounging around on their yacht. True? The truth is there are no “gurus”, there are only people with good information and common sense. This is all the world’s greatest investor, Warren Buffett uses. Good old-fashioned common sense, a commodity not often used in the hustle and bustle of share trading and investing.

For instance, look at your portfolio; do you know why you own shares in each of these companies? What compelled you to buy these particular shares? Do you know what they do? What is their compound earnings growth for the last 5 years? What is their estimated earnings growth for the next 5? You need to have answers to these questions, before you buy the company, not after.

The major and only real reason to invest in a company is for its earnings – current and future. Without earnings or the 100% guaranteed prospect of future earnings, the company is worth nothing, that simple.

Would you really want to invest in a company that has very little chance of making a profit in the future? So, why do some investors invest in “penny dreadful” mining shares or those “dot com” companies?

Many of these companies will never make a profit. The reason they invested, is because they have probably been swept away by emotion, greed to be exact – no common sense there. This is my point, common sense dictates that you would probably be a fool to invest in these companies, but people still do.

My philosophy is simple, look for earnings growth. Where earnings growth goes, the share price will always follow. Sure, the market will have its ups and downs, but at the end of the day, growth in earnings will always win out, it always has and always will. So, how do you identify these companies with strong earnings growth?

Sometimes it’s not easy. While some brokers are often (my opinion only) a poor judge of picking stocks, some do have pretty good research departments and analysts who, based on what the particular company’s executives tell them and also reflecting on recent history, can often come pretty close to predicting the earnings not only for next year, but up to five years out with uncanny certainty.

The best I’ve seen are the New York analysts. These guys are good, they can predict a company’s quarterly earnings within a cent or so. However, this doesn’t make them good “pickers” of stocks, you need also to apply your common sense to this information. For instance, the company might be showing good earnings prospects according to the analysts, but will it last?

What I mean is, are the company’s products or services in great demand? Are they always innovating and coming up with new products? Does management appear to be good? Are they consistent with their growth? Is the future profit growth compounding at 10% or more, past and future? Does the future prediction of growth sit comfortably with the past? Bottom line – Does the prediction make sense?

If the answer is yes to all these questions…. You better buy some shares in that company! Now reflect on your portfolio again….…….. “Hmmmm….oops”, could be your reaction here. Common sense has kicked in hasn’t it?

Would you like the name of a company that has consistent 15% earnings growth for the last 10 years? A company that has predicted future growth of around 15%? A company with a record of share price growth compounding at over 15%pa? A company regarded by many as the best in the world and with the best management and CEO? Also, it’s products are regarded as the among the best in world. It’s General Electric Co. of the US. Your broker in Australia can buy shares for you, it’s that easy.

There are many companies out there that make similar claims, it’s just a matter of finding them. This takes time and effort, however it’s well worth it, just don’t forget to use common sense.