4 Keys to Profitable Investing
In this post, I will be talking about the 4 Keys to Profitable Investing.
If you want to achieve consistent profits while investing in the stock market, you must read this.
What To Buy – 20% of success
We only want to buy very good businesses because when you are buying a stock, you are buying part of a business.
This is based on fundamental analysis. You will have to study the company’s profit & loss statement and balance sheet to know if they will grow over the long term.
You only want to be buying shares of fundamentally very good companies that are going to grow in value.
The criteria that make a company a good investment is:
- History of consistently increasing sales revenue, net profit, and cash flow
Look at the charts below:
For General Motors, the earnings are inconsistent and lost money over the years, and you do not want to invest in such companies.
When a company has erratic earnings, the share price tends to fall over time
What you want is a company’s charts that look like this:
You want to invest in a company where the profit grows consistently. When it grows, the share price will tend to increase consistently over time too.
- The company should have insiders accumulating shares
- Price of the stock to be below intrinsic value
- Company must have a sustainable competitive advantage with a strong business model that will ensure that it will continue to raise profit and sales in the medium to long term
- We only want to invest in companies with double-digit growth potential
- The company must have a conservative debt structure
How Much To Buy – 10% of success
Another 10% comes from knowing how many shares to buy. This should not be dependent on your emotions or your guesswork. This should be based on your mathematical calculation, risk management and position sizing.
Let’s take a look at my example below:
Now that I’ve bought Goodpack and I’m risking 2% of my capital, can I buy shares of another company?
Sure I can.
I am looking at Yahoo and it was in a consolidation pattern before it broke out.
With the example, I am buying it at $17 and putting a stop loss just in case I am wrong, and the price comes back down. I am also going to put a profit target at $22.
I calculated the intrinsic value of Yahoo and found that the share is worth $22, hence the price has to go at least to $22.
My risk per share is $1.50 ($17 – $15.50) and the worst that can happen is losing $1.50 for every share I buy.
If the price goes to my profit target, I can potentially make $5 per share.
I am risking $1.50 to make $5, and my Risk/Return ratio is 1:3.
As long as your Risk/Return ratio is 1:2, you’re taking an investment.
So how many shares should I buy?
I take my risk per trade (2%), multiplied by my capital ($10,000), and then divided by risk per share ($1.50), which results in 133 shares.
After buying Yahoo, can I still buy stocks of other companies?
Look at the chart below:
Notice that my risk is always the same, but the return is different. The return depends on the stock.
Some have the potential to go higher but your risk/return ratio must be at least 1:2 – your return must be at least 4% for you to take the investment.
I have got 4 positions and my total cumulative risk is 8%. If all 4 of them fail, I lose 8% of my capital. But if all 4 hit their profit target, I make 26%.
Of course, we may not win all our investments or lose all our investments, but we aim to be right more than half the time.
So, what is the secret to getting consistent profits?
The secret is to think statistically and to think in terms of probability.
My suggestion as an investor in the medium to long term is to do roughly 4 trades a month.
In a year, you would have 48 trades.
Let’s assume you have a win rate of 70%. Statistically, you will have 33 wins and 15 losses. Each time you lose, you will lose 2% (from the stop loss), a total loss of 30% from your capital.
At the same time, for each winning trade, we make at least 4%, a total of 132%.
In conclusion, you will get +102% returns on capital.
This is very achievable but it’s not easy.
To be more conservative, aim for a 60% win rate.
Statistically, you will have 29 wins and 19 losses.
Leading to a total of 38% loss and 116% wins which totals up to +78% returns.
When To Buy – 30% of success
30% comes from knowing when to buy. You only want to buy when the price is going to move up. You don’t want to buy the stock and have the stock going sideways for months and years. Knowing when the price will go up is based on technical analysis and reading chart patterns to know the emotions of the market.
You only want to buy a stock when the price is below the intrinsic value of the company. You also want to buy when the price is undervalued and on an uptrend. NEVER ON A DOWNTREND!
Let’s take look at the chart below:
You can see the intrinsic value of UOB to be at $20 per share and because of temporary bad news and recession, the price fell to $17 (undervalued).
Many people think that the price is low and they want to buy, but remember, never buy on a downtrend, because cheap can get cheaper and at its lowest point, it was priced at $8.
This is why you always wait for the trend to reverse into an uptrend! You can use moving averages to identify market trends.
When To Sell – 40% of success
The last 40% comes from knowing when to sell! That’s the most important thing as an investor. You want to sell when the price reverses into a downtrend, exit and lock in profits.
The mistake that many investors make is when they focus all their time and energy on only the first key – they always ask what stocks should they buy. But knowing what to buy is not good enough because you can buy the right stocks and company at the wrong time and end up losing money or breaking even for many years.
As a good investor, you should be making money every single year.
That’s the beauty of this system. As long as you follow the rules of what I teach, you will be able to make profits consistently every single year.
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