One of the most critical terms to be familiar with as an investor is alpha. Alpha is the risk adjusted return a security has. In layman’s terms this means if you buy a high risk stock, you are expecting high returns and if you buy a low risk stock you expect low returns. The reason why the website I write for is called Seeking Alpha is because investors try to find scenarios where there is low risk and high returns. Sounds like the perfect situation doesn’t it?
So how do you buy stocks that have a low possibility of losing money and a high probability of making huge gains? There is no one way to make money in the stock market. There is no silver bullet which works every time. From my experience the best way to make money is to have the best analysis.
How can you have the best analysis when information is so readily available? My answer to this question would be just because the information is there for everyone doesn’t mean everyone knows how to interpret it correctly. In fact on every stock at every moment there are buyers and sellers because people have different opinions about where a stock will go. Only one of the two sides will be right. The side which is right is either right because he/she is lucky or because he/she has done better analysis than the person on the other side of the trade.
Let’s ignore the guy who is lucky because he should not be copied. Let’s focus on the person who did the best analysis. How did he/she do it? There’s a lot of ways this can occur, but the best way is through in depth research. You must have a deep understanding of the company and the factors which determine its success.
Sounds boring doesn’t it? I know what you’re thinking. “I really, really do not want to do research.” This is because you are viewing research in the wrong way. Some of my research would be considered boring to most people such as when I analyze the frac sand market by interviewing CEOs of the companies in the industry.
It’s not all boring, however. The way I am advising you do research is by talking to your friends to try to spot trends. For instance, I’m sure most of your friends hate McDonald’s, love Chipotle, and love Netflix. That’s your edge. It may not sound like an edge, but the analysts on Wall Street and the money managers are generally much older. They rely on survey results to spot trends. You are part of the demographic which is being surveyed, meaning you have special information which you can use to make money. I know how this situation works because every few months money managers are trying to figure out if Facebook is still “cool” with young people. They have no idea what is cool and what isn’t. You do.
Just to be clear, I am not advising you to go out and buy Netflix purely because you and your friends use it 2 hours every day. You should use this as the starting point of your homework on a stock. The Netflix conference calls are actually on YouTube and are not too boring because they are discussing shows such as “House of Cards” and “Orange is the New Black.” It shouldn’t be too difficult to pay attention to what management is saying.
On a final note, you can use this advice in two ways. You can start with exciting stocks like Netflix to ‘wet your beak’ before building a full portfolio of stocks which aren’t all growth oriented like Netflix. The other takeaway is to use only a small amount of your money to invest on your own if you are only interested in the more risky stocks like Netflix and Shake Shack.