13 Steps to Investing Foolishly - Step 6

Step 6: Discover Great Businesses

When you buy a stock, you're purchasing a stake in a living, breathing business. Buy shares of your favorite fast-food joint and you own the place. Literally. Every time someone gets fries with that shake, a tiny bit of cash drops to your company's bottom line. High five, shareholder!

Finding great stock ideas is as simple as opening your eyes. Your fridge, medicine cabinet, wallet, computer: all hotbeds of stock ideas. Behind virtually every successful product or service lies a publicly traded company that's cashing in on that success -- and that you can join as a business partner.

Better know a better business
But a great service or product does not a great investment make -- just ask anyone who invested in Webvan during the dot-com era. (Never heard of it? Yeah, that's kind of our point.) Again, think of buying shares of a company just like buying a stake in a local small business. Does the business have staying power? How much cash flows in and out? Do you trust the management and employees to do right by you as an outside investor? Hardly questions you'd need a Harvard MBA to spell out for you, right?

Fools take the same commonsense approach to investing. We're interested in the strength of a business. Not past performance, charts, or whether the shares have split.

Specifically, here are a few things we look for:

1. A sustainable competitive advantage: Some businesses have unique, lastingcompetitive advantages that allow them to earn outsized profits. The more durable a company's competitive advantage, the larger the "moat" that surrounds its financial fortress. ADP's scale and high switching costs, eBay's network effect, and Johnson & Johnson's intellectual property are all classic examples of sustainable competitive advantages.
2. Cash aplenty: Cash is the lifeblood of any business. It pays the bills and covers the tab for new growth projects. Fools look for low-debt, cash-rich balance sheets and steady cash flows.  Specifically, free cash flow -- the cash left over after funding operations and growth -- fuels share repurchases and those sweet, sweet dividends that show up in your brokerage account every three months.
3. Strong leadership: Is management invested alongside you? Do they have a history of creating value for shareholders? Do they have years and years of relevant experience? Do they treat outside shareholders (business partners) with respect?

If you stumble across a company that nails all of the above, odds are good that you're looking at a great candidate for your hard-earned cash. So you've done your homework. Now what?

Cheat. Yes, cheat.
Thanks to this wondrous Internet-thingy, getting second opinions on stock ideas is just as easy as finding the ideas in the first place. Turns out there are legions of investors just like you freely sharing their ideas, thoughts, and research. 

[ INVEST ]

Comments here