15 Rules To Consider When Buying Stocks

1. Of course, never buy anything popular. History says the odds are against you.

2. Avoid new technology. Wind power, solar power, recycled water businesses, technology businesses. Historical odds are against you. There are easier ways to make money.

3. Buy businesses with plenty of “customers”. It’s like real estate. Real estate moguls find it a lot easier to buy apartment buildings than single family homes because apartments provide multiple sources of revenue. Houses provide one, and investing in real estate through single family homes is a heck of a lot tougher. Same goes for stocks. Buying companies like Colgate (loads of customers) over Boeing (a few customers) is a much safer way to make money over time, because if one source of revenue dries up (one guy stops buying toothpaste) there will be plenty of others to keep up the revenue flow.

4. Buy businesses you can understand. If you can’t explain how the business makes money (to a five year old) then you shouldn’t own that business.

5. Don’t “trade”. Studies all show that (on average) those who trade more frequently don’t perform as well as people who “buy and hold”. This rule applies to mutual fund owners, index fund owners, stock investors, and even mutual fund managers.

6. Buy businesses that can increase the prices of the products they sell. This puts a strike on technology companies (computers and cell phones get cheaper every year) and a check in favour for companies like Harley Davidson, Coca Cola, Pepsi, Nike and Genuine Parts (which sell products that cost more over time)

7. Buy a business that any idiot can run. One day an idiot will run it. Buffett said it first.

8. Don’t get hung up with investment related media. Such as television like CNBC, and don’t get investment advice from magazines or websites (including famous groups like the Motley Fool). Call this an opinion, if you like, but studies support how disastrous it can be. I listed these in order of danger. Listening to CNBC is one of the worst things an investor can do. And I know, firsthand, that you can’t sell magazines by telling everyone to buy index funds.

9. Buy companies with low debt levels. With an average of the last three year’s worth of net income, can they pay off their long term debt in less than a year? This rules out most businesses but it’s a sign of financial strength if a company can do this. For example, if a business made $4 million one year, then $5 million the next and then $6 million the following year, it’s average 3 yer net income would be $5 million.
Then look at the debt level. If long term debt is $5 million or less, this is OK. The safest bet of all is buying a business with no debt. You’ll find plenty if you look.

10. Buy businesses with CEOs who don’t pay themselves extravagantly. If you don’t know how the CEO’s pay compares with CEOs of other (relatively equal) businesses, you shouldn’t own the company’s stock.

11. Think of yourself as a business owner. The CEO is your employee, not your guide. Never listen to him or her for guidance. They tend to want to keep their jobs, so they’re the biggest company cheerleader.

12. Buy businesses with high returns on total capital. If you don’t know what this means, find out.

13. Buy businesses with consistent net income increases and consistent increases in earnings per share (over many years). You won’t find increases every year, but look for rising three year averages.

14. Buy businesses that only buy back their own shares when the price of their stock is cheap. Don’t buy businesses that buy back shares at silly prices.

15. Make sure you get it at a good price . Don’t blindly buy a great company without ensuring that you’re getting a great deal.

For now, the 15th rule can almost be ignored. Stocks are cheap. Enjoyably cheap.