Question

In June 2018 “Xiaomi Corp. and some existing investors raised $4.7 billion after pricing a Hong Kong initial public offering at the low end of a marketed range, a person with knowledge of the matter said. The Beijing-based smartphone maker priced the sale of 2.18 billion shares at HK$17 each, the person said, asking not to be identified because the details are private. Xiaomi had offered the shares at HK$17 to HK$22 apiece. The pricing values Xiaomi at about $54 billion, roughly half the company’s initial goal.” Explain the core principles that are relevant to investors’ decision to buy or not to buy the stocks.

Answer 1

10 Fundamental Investing Principles for buying a stock

1. Embrace an Investing Strategy

It’s important to know what kind of investor you are and adhere to the principles of your investing strategies. What kind of investor are you; value, contrarian, growth at a reasonable price, growth, or momentum?

If you choose to be a value investor you are at the right place to learn more. I believe investment decisions should be valuation-based. Whichever investing strategies you choose, maintain a consistent approach. In other words, a value investor should not be participated in momentum investing.

2. Invest With a Margin of Safety

If you buy an asset for less than its real value you have a margin of safety. One of my favorite sayings is: Price Matters! The best plan to lower risk is to buy investments at a price that is lower than the real or intrinsic value.

A low price means greater upside appreciation if conditions are favorable. At the same time, a low price provides a margin of safety if circumstances are not ideal. Always plan on less than ideal conditions, something usually goes wrong.

3. Asset Allocation is #1

Your asset allocation, how you divide your portfolio among different asset categories, will be the biggest determinant of your investment returns. I find this is where many investors fail because they put little thought or effort into their asset allocation strategy.

If you place your money into overvalued asset categories you will experience poor long term returns. It’s important to overweight asset categories that are bargain priced and underweight or avoid asset categories that are expensive.

4. Diversification is Vital

Investment diversification in small numbers provides enormous benefits. In other words, five investments is much better than two, ten investments is better than five. However, the marginal benefits of adding additional investments decreases as the numbers get larger until the costs become greater than the benefits.

Both under diversification and over diversification are common mistakes made in portfolio management. Most studies show optimization occurs somewhere between 15 and 30 individual investments.

5. Invest For the Long Term

Short term investing is one of the biggest downfalls of current investing strategies. The truly great investors realize if you buy an investment at a favorable price it may take time for the market to recognize its true value.

Long term investing is one of the most important investing principles because short term trading usually leads to poor long term performance. This is common because many investors let fear and greed cause them to make bad decisions. The long term will take care of itself if you make wise investment decisions.

6. Keep Expenses Low

Most investors don’t realize how much difference high expenses make to their portfolio. Take a look at the what happens to your returns with a 1% higher expense ratio;

Assume:

-$100,000 lump sum investment for 30 years.

-6.5% real rate of return less 0.4% expense ratio for self directed investor.

-6.5% real rate of return less 1.4% expense ratio for investor with high fees.

=Real Rate of Return of 6.1% for self directed portfolio grows to $590,829

=Real Rate of Return of 5.1% for investor with high fees grows to $444,715

The Difference is over $146,000!!!

In other words, over a 30 year period, an increase in expenses of 1% can cost your portfolio more than the original principal!

7. Use Compounding to Your Advantage

Compounding or exponential growth (they mean the same thing) is a powerful financial concept. Understand how it works for you and why dividend growth compounding multiplies the value of compounding.

It’s equally important to understand the devastation of reverse compounding. The more of your portfolio you lose the harder it is to make it back because you lose your principal. A 10% loss only requires an 11% gain to get back to break-even. However, a 50% loss requires a 100% gain to get back to break-even.

8. Employ Risk Management Strategies

Because it is so important to not lose your principal you must employ risk management strategies. Portfolio volatility is an investment return killer. If you don’t control risk you will suffer greatly in bear markets. Avoiding large portfolio drawdowns should be one of your preeminent investing principles.

9. Anticipate Market Volatility and Make it Your Friend

Despise portfolio volatility but embrace market volatility. You can control portfolio volatility but you cannot control the inevitable volatility of investment markets.

Therefore, you should be prepared to take advantage of investment opportunities. At the same time, you need to be cognizant of overvalued assets and be willing to move to cash when conditions are unfavorable.

10. Control Your Own Destiny

No one cares about your money more than you do. Wall Street fraud, conflicts of interest, and outrageous fees make self-directed investing an attractive alternative.

Technology and the internet have brought down transaction costs and provide the means to get information and guidance at a very low cost. There has never been a better time period for the self-directed investor who is willing to put a little effort into investing.