‘Don’t ever buy individual stocks’ is pretty good advice, especially if you are a long-term investor. You are much better-off just buying and holding a passively managed index fund like one tracking S&P500. For good reasons.
It’s extremely hard to beat the market through an actively managed portfolio, even for the pros. You are up against very smart investors and institutions who are well armed to squeeze profit from every trade. Even if you are highly motivated, you likely won’t have the knowledge or time needed to outsmart the best. Individual stocks also don’t have in-built diversification of index funds that’s needed to reduce risks.
Despite that, there are still very good reasons to learn to critically analyze individual companies.
#1 You become a better thinker. When you analyze businesses, you learn how the world works. You develop grasp of specific industries, consumer behavior, finance, pricing, psychology of market participants, business strategy, and so much more. Brick by brick, and idea by idea, you build an understanding of key mental models to make sense of complex world around you.
#2 It helps you to exploit your unfair advantages. You might have some deep insights in an industry where you have worked for decades or are passionate user of some niche products. Whatever is the reason, you have greater intuition about something in the world. Most of your wealth can be in diversified index funds, but you may want to invest a part of it in select businesses that you understand better than others. Knowing how to evaluate individual stocks can turn raw ideas into promising investments.
#3 You will take better life decisions. If you are in market to buy small local business, you can accurately assess the quality and price of that asset. Or if you ever plan to start a business yourself, you would know what it takes to design a good one and what traps to avoid. It can even help you if you are an employee who receives stocks as part of compensation. You can make smarter calls whether to keep or sell at each vest, or negotiate harder during a raise to get more stocks if you think they are undervalued today.
However, it’s crucial that you learn this skill yourself and don’t rely on others to do the thinking for you. There’s so much noise and conflicting information out there. From TV channels to Youtube influencers to TikTok experts, everyone is broadcasting their opinions and offering tips. If you are not careful, you either end up more confused or tune out contradictory information to confirm your own biases. You cannot make sound investing decisions on borrowed conviction.
So you must develop a process to quickly analyze a businesses without letting it overwhelm you. You need a framework through which you can systematically filter out noise to arrive at sound conclusions. Every investor worth their salt has a process. You should have it too. It might sound hard given how complex it is made out to be, but it’s really not.
My goal over the next few posts is to share a playbook that I used for more than a decade to make long-term investments with decent success. The framework I present is simple, but rigorous. It won’t demand convoluted financial modeling or analysis. It’s for everyday investors like you and me to help us systematically research and develop a point of view on an opportunity for a few hours of effort.
You will learn to dissect how a business works, how to check its health, how to identify its competitive differentiations, its risks, opportunities, and a reasonable price you are willing to pay for it. I will explain key financial ratios, accounting terms, and extremely simple ways to think about valuation. You will turn your raw ideas into a clear investment thesis that can be summarized in crisp 1-pagers.
Learning to invest in individual stocks is not for everyone. But if you want to become a better thinker, exploit your unfair advantages, or take better life decisions, learning to invest will pay huge dividends. It will take practice and bit of time to get good at, but that’s how everything worth doing is done.