How to Invest in Stocks by Rule One

According to the always interesting investment icon Warren Buffett and the newer but also successful investor, author and speaker Phil Town, Rule One is easy: Never lose money. Rule Two is equally straightforward: Always remember Rule One. Buffett's investment strategies still evoke some criticism from those who love the "excitement" of frequent trades. However, even for those who believe Buffett's prime strategy, buy and hold, is a bit boring, Town is a Buffett disciple and has the riches to prove Rule One works.

Step 1

Set your criteria for potential stock buys. Rule One investing suggests that you find fundamentally strong companies, projecting long-term success. Look for companies that have been somewhat ignored by the market. Your personal investing criteria for companies that meet these basic requirements is your option. Whether you use another proven expert's methodology, such as Phil Town's Rule #1, or develop your own criteria checklist, this should be your initial step.

Step 2

Compare stock prices. The second component of Rule One investing is to buy stocks that appear to be under-priced as compared to their rank on your criteria checklist. Comparing stock prices of companies that score well on your criteria checklist will display those that meet the under-priced component. You typically learn that the best buys are suffering significant price decreases. Rule One investing alerts you that these are buy signals since the stock is available at a discount.

Step 3

Examine the critical company financial data and ratios that signify good investments. These include return on investment capital, sales revenue and growth; increasing earnings per share; true company book value; and unencumbered cash flow. While these ratios will be modest, the Rule One investing key is that these numbers should be growing consistently.

Step 4

Evaluate management quality. You must be satisfied that current management is sufficiently talented to take the company to the success you project -- and want. All the product, financial and apparent market strength on the planet can be negated by mediocre management teams. Conversely, strong management teams only enhance the probability of success, particularly for fundamentally sound organizations.

Step 5

Prepare to sell if your carefully selected company encounters problems. While Rule One investing is a buy and hold strategy, unexpected operational, marketing and financial problems can turn a stable, growing company into a risky adventure. If this happens, your Rule One program can become a buy and hold, then sell strategy. Remember Rule Two: Always remember Rule One. Do not lose money by holding stock in a company that's in a declining spiral.

Tip

  • Follow the sequence of identifying sound companies and then comparing stock prices as buy and hold strategies, like Rule One, depend on fundamentally solid organizations.

Warning

  • Don't be tempted to sell as your Rule One stock increases in price. This buy and hold strategy typically indicates sell only when companies face serious problems. Don't fall in love with your companies. Unlike day traders, buy and hold investors often get to know their companies. Love can be blind in personal relationships and Rule One investing. Remain objective and dispassionate.

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