“The hardest virus to kill is an idea,” said the character of Leonardo DiCaprio in the movie Inception. This idea – of the difficulty of killing an idea – is widely prevalent.
We see this in businesses where once a management gets an idea that sounds wonderful, it is very difficult to ask it to change its plans even if the idea is destined to fail.
Things aren’t any different in stock market investing.
Investors seldom expect to be wrong, and thus hold on to bad ideas – bad stocks – even when it seems clear that their original idea was faulty.
But this is a typical behavioral attribute and you can’t blame anyone who shows this kind of a tendency – of not accepting that his idea is bad, and therefore must be killed.
In this post, we look at the relevance of killing bad ideas in stock market investing, and how you as an investor can do that.
There are great risks in holding onto bad ideas, so you won’t want to miss out on what this post has to suggest.
So, let’s get started.
How do you decide which investing ideas to kill?
As an investor, you will have several stock investing ideas on your plate at a given point of time.
It’s not just one idea; you will have a bunch of ideas – some that you research on your own, some that you are advised by your friends and colleagues, some that you get from the television or Internet media.
Some of these ideas will look like giving you great returns in the long run, some will give you medium-sized returns, and some ideas will be very risky and will be breakthroughs if you succeed.
But how do you know which stock ideas you have are good, and which aren’t?
The world’s most successful investor ever, Warren Buffett follows a simple way to kill his bad stock ideas.
He categorizes companies into three lists – In, Out, and Too Hard.
- The ‘In’ list is the smallest one, carrying the names of companies that Buffett understands very well, and that are simple businesses.
- The ‘Out’ list is made up of companies that Buffett tries to understand first, but doesn’t. He transfers them to this list.
- The ‘Too Hard’ list is the biggest. Buffett once revealed that 99% of the stock ideas that came to him found their way into this list.
You can use a simple test to determine whether an investment idea you are looking at is an ‘In’, ‘Out’, or ‘Too Hard’.
If you do not understand the company’s business in five minutes…it’s ‘Too Hard’.
If you do not love it ten minutes after that, it is ‘Out’.
But will that eliminate 99% of your investment options as it did for Buffett?
Yes…and that’s the point!
There are more than 8,000 businesses listed on the Bombay Stock Exchange alone. If 99% of them are ‘Too Hard’ or an automatic ‘No’, then there still are 80 or so out there that are truly wonderful, easily understandable businesses worthy of being in your ‘In’ list.
Anyways, not all these ‘In’ ideas will be the ones you must pounce on.
Of course, each of these is simple, brilliant businesses. But before buying a stock, you must also consider its valuations – how much the stock is trading at as compared to the business’ intrinsic value.
A stock whose market price is higher than its intrinsic value must be shifted to the ‘Out’ box, and one whose price is 30% or lower than the intrinsic value is the one you must buy.
These are your ‘good’ ideas. Rest everything is ‘bad’.
Is killing ideas integral to investing?
Yes, killing bad ideas is, because the success rate of good ideas is not going to be 100 percent. If it’s 100 percent, you’re not thinking or working hard on your ideas enough.
Even Buffett doesn’t have a 100% success record. In fact, his company Berkshire Hathaway used to run a highly unprofitable textile business when Buffett took it over. He had to ultimately sell the textile business at a big loss.
In the same ways, not all of your investing ideas will be worthy of an investment. In fact, as we saw above, only a very few would be. So, don’t worry when you have to kill an idea.
Does killing an investing idea mean it’s gone forever?
Now, when I say kill the idea, it does not really mean kill the idea. You could come back to it again in the future. Like for a stock that you don’t buy just because its stock price is expensive as compared to its intrinsic value.
Such ideas must be killed ‘temporarily’ but you must definitely look at them when situations change – like when stock markets crash and stocks across the board fall significantly.
Kill that idea before it kills your wealth
I have been a stock market analyst and an investor for the past eight years. And, to say the least, I have been rather frequently – and on occasion, quite spectacularly – wrong. But that is something I always expect to be.
No one really knows what is going to happen in the future. This is especially true when it comes to the stock market. So why pretend otherwise?
That’s the reason it is very important for you to scrutinize every stock idea that you receive – whether from an expert, or from your own research.
And the, the more critical part is to kill the bad ideas that do not stand your test of quality businesses. Because if you do not kill the bad ideas, and in fact act on them, you will be setting yourself and your wealth for a major trouble in the future.
But first accept that the ‘great’ investing idea you have can in fact be a ‘bad’ idea.