Picking the right company to invest in is like trying to pick up a grain of sand in your rice with your chopsticks.
To come out unscathed, one needs to avoid a lot of investment follies.
But everyone makes mistakes.
Fortunately, simply avoiding the biggest mistakes is sufficient for you to do well.
The following are the biggest sins I think we should strive to avoid.
1.
Buying with little or no margin of safety.
"The three most important words in investing.
" is how Buffett described margin of safety.
Margin of safety allows room for errors in our assumptions about a business.
Because the intrinsic value, the present value of all future expected cash flows, of a business is calculated based on assumptions derived from incomplete data, we are bound to make mistakes in our assumptions.
A margin of safety will not guarantee a profitable investment.
But it tips the scales and puts the odds in your favor.
If the company turned out to be worth half what you projected, you would still be getting the shares for a fair price.
2.
Insufficient due diligence.
Before placing your life savings in the hands of a CEO you've never met, it is important to do your homework.
People often refer to this as doing your due diligence.
But I think the term "due diligence" is too loosely defined and often played down.
Due diligence is reading annual and quarterly reports word for word, proxy materials, and everything you could find about the company.
Due diligence is understanding the market the company operates in.
Due diligence is reading the competitors annual reports.
What due diligence is not is listening to your friend's overly optimistic projections of the 2009 Amazon's (AMZN) Kindle sale.
3.
Following a guru blindly.
I'll be the first to confess this sin.
I've followed one of my favorite gurus, Mohnish Pabrai, into Delta Financial (DFCLQ).
Yes, I can already hear your jeers of derision.
For those of you who missed the story about Delta Financial, the company went from a promising multi-bagger to a worthless piece of crap.
When asked about his bet on Delta Financial, Pabrai responded, "It was a good bet.
" For Pabrai, maybe.
For me, it was stupid.
I followed Pabrai blindly.
I didn't understand that the ability to securitize loans is the key to survival for loan originators.
And Delta couldn't securitize.
So it collapsed.
I hate to end your schadenfreude so quickly, but I only held Delta in a mock portfolio.
One great lesson learned nonetheless.
4.
Buying on margin.
Buffett in his speech to Emory University students said, "Over the past 50-60 years, Charlie and I have never permanently lost more than 2% of our personal net worth on a position.
We've suffered quotational loss, 50% movements.
That's why you should never borrow money.
We don't want to get into situations where anyone can pull the rug out from under our feet.
" The biggest problem with buying on margin is your broker gets to sell your stock without any prior notice should the stock price fall below the broker's maintenance requirement.
You lose your chance to ride the potential rally and you're stuck with losses plus interest owed.
5.
Buying the hot stock.
If mentioning Apple (AAPL) in this paragraph is not going to flame my inbox, I've no idea what will.
Admittedly, Apple has done magnificently well - rising 1500% in the past five years.
My friends and relatives can't stop whispering into my ear, "The new iPhone 3Gs are going to sell like hot cakes.
" Frankly, I don't know how Apple's gonna perform in the next five years.
But buying the stock simply because you own an iPhone is wrong.
Buying the stock simply because your friend can't stop talking about it is wrong.
The only reason you should be buying the stock is if you have determined the stock is undervalued.
What other mistakes that you think we as investors should avoid? Full disclosure: At time of writing, I do not have positions in any of the securities mentioned in this article.