Binary Nature of Investing

It was Warren Buffett who once said, “Buy a business, don’t rent stocks.”

Yet, words of the Oracle of Omaha are far too often ignored, as many investors make the mistake of focusing on stocks and their performances in the stock markets at the expense of focusing on the actual businesses they are buying into. Agreed, this sounds very much like making a distinction without a difference, but bear with us.

First Binary Combination - Are Good Companies Also Good Investments?

One of Mr. Buffet’s most important lessons was to first analyze the business. Then, and only then, if an investor likes what he or she sees—invest, by all means! In other words, investors should avoid playing a dangerous game of trying to "divine" whether a stock is going to go up or down in the short run. It is difficult to do this well, and near impossible to do it consistently. Instead, focus on what a company has to offer that might sustain its growth and consistent fiscal performance in the long run.

In this day and age, there are swarms of institutional analysts, independent stock researchers, promoters, what have you, all of whom, on any given day, are making just as many different predictions about the next hot stock you simply must buy, about market trends, business cycles downturns or upturns, etc. If they guessed it wrong, you will never hear from them again. If they were right, they are likely to be endorsed as financial gurus even if they are never right again!

The truth is that so far no one has invented a working crystal ball. The market offers no magic bullet or surefire investment solutions. The best that long-term investors can do is to focus on identifying companies with consistent financial performance and strong fundamental prospects that, preferably, are also undervalued and flying below the institutional "radar."

This brings us to the first binary combination—there are many good companies, but not all are necessarily good investments! What investors should be looking for are: 1) good companies at, 2) the right price. A good company can be too expensive, while a bad company is never cheap enough.

To help you along the way, we recommend “arming” yourselves with a few tools of the trade, such as how to utilize the capital asset pricing model (CAPM) when evaluating expected returns of securities, or how to evaluate a stock’s risk with its beta, or what can be learned from the Price-to-Earnings (P/E) Ratio and PEG Ratio.

Second Binary Combination - Being Right and Being a Contrarian

Another typical problem investors face is that even if and when they have identified a good company at the right price, it may still take time and patience to see their strategy unravel. Hardly ever investment decisions result in overnight profits because usually it might take a while for the market to absorb certain bullish fundamental developments and factor them into stock prices.

It has often been said that money can be made in any kind of market, be it bullish or bearish. To make money in the financial markets you need to be, obviously, (1) correct and, less obviously, (2) contrary, which is our second binary combination of good investing. Or, in other words, you can be correct, but if everybody else agrees with you, your chances of outperforming the market decrease exponentially.

By searching for fundamentally solid companies, you are removing yourself from the game that is inherently rigged, and instead, participating in the worthwhile activity of finding businesses that can put your capital to good use. Remember Warren Buffet's words, this is what prudent investing is supposed to be—allowing companies “to rent” your hard-earned money, so they can grow their business and pay you back the dividends through market performance.

Anyone serious about stock research and investing subscribes to popular industry journals. If you like tech stocks, you need to read tech periodicals. If you like science, read up on science. This strategy means letting the market gyrate on its endless recirculation of sentiment and multitude of opinions, while you locate expertise that will help you find growth companies worthy of your money.

In Pursuit of the Market

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