Step 1: Identify Very Good Businesses



Always remember that when you are buying a stock, you are not buying a lottery ticket but you are buying part-ownership of a company. If you want the value of your stock to increase over time, you must identify and invest in very good businesses. Thus, you must truly understand the business behind the stock. All master investors invest from a business perspective.

What is a very good business? It is one where we can predict with confidence that, over the long-term, it's annual earnings and hence stock value will increase (if a company can make increasingly higher profits in the future, it would become more valuable). When the value of the company increases, the stock price will eventually increase.

While bad news and disasters like wars, recessions and new competition will always cause the market to panic and stock prices to plunge, a very good business is one that we are confident will always recover and prosper after such events.

In this case, you don't have to depend on market predictions for your stock's price to rise, but you are certain it will rise because of its strong business fundamentals and earnings.

Step 2: Buy them Only At A Huge Discount

Very good companies with strong earnings, financial strength and high growth potential are usually expensive to buy (the stock price is overvalued). However, the market always goes through booms and busts and there will always be short-term bad news that hits a company (e.g the company reports lower than expected profits). It is under these circumstances that the irrational short-term orientated market will panic and sell the stock until its price is way below its intrinsic value.

The master investor, knowing the true value of the stock, will buy as much as he can at such times, thereby getting a huge 'discount'. He knows that the market will eventually come to its senses and recover, correcting the stock price and bringing it up to its true value. This is when very substantial returns are made for the investor who is patient and confident in his purchase.

Step 3: Wait for the Market to Realize a Stock's True Value or Overvalue It.

The best time to sell is when the stock market is booming or there is good news that makes the market overreact. Investors will flock to buy up so much stock that the prices of all stocks rise above their intrinsic value. When a stock is highly overvalued, it is a good time to sell as you will make a huge profit.