It is very well documented that consistently beating the market returns over the long term is the privilege of only a happy few. Expert traders fail at it all the time. That’s why most recommendations out there will be a variation of “invest passively in index funds or ETFs, diversify and rebalance annually”. The thinking behind this is “If you can’t get better returns than the market, at least get the market’s returns”.

For most cases and certainly for the majority of your portfolio, this is wise advice. However, if you feel like betting a small portion of your net worth on specific stocks, you will have to adopt a more active approach to investing.

Stock picking should be done very cautiously and you should invest a lot of time understanding the companies you are investing in. It is also much riskier than index investing as any one stock can go to zero and you could lose the entire amount invested (which is a lot less likely with index investing).

Don’t invest in a stock if you just heard about it, whether it’s from a renown expert or a rando on the internet, unless you do your own research.

Some people will invest in the same stocks as public figures or just select the ones that are the most talked about on TV. You should know that by the time you get the information, many institutional traders will have been on it and will have already harvested most of the short term gains.

Instead of that quick and dirty approach, if you are going to be stock picking, you really should spend some time understanding the companies behind the stocks. At the end of the day, when you invest in a stock you are buying a piece of that business, so you should act as a business owner.

Other Value in Value Investing

There are many books and resources out there on the different financial ratios and formulas to look at when probing a business. These are very useful to find out two things: 1/ is the company financially sound? and 2/ is the share price a good bargain?

Those considerations are great and can be very useful. I would argue that for long term investors, only the first point matters. Of course you don’t want to overpay your stocks as this can have a negative impact on your returns, but in the grand scheme of things, if the company has strong financial foundations and passes your other criteria (see below), then the price its stock is selling at right now doesn’t really matter, it should still produce interesting returns in the long term, even if it has to start by dropping a little. Plus, if you spread-out your purchase over time, you can benefit from dollar-cost averaging which makes the current price a total mute point.

But there is more than the bottom line to look at when investing. Of course the financial health of the companies you are investing in is fundamental, however, it should only be the first filter.

I would strongly recommend deciding what other criteria you think businesses should pass as a second filter and apply that before deciding if they deserve your money.

I’ll share below the criteria that I use, for what it's worth. I don’t invest in businesses that don’t pass these criteria, even if they make a ton of money and provide great returns to their shareholders. I try to make it a matter of principle.

Market and Product

The holy grail of the startup industry is product-market fit. But it may as well be considered the holy grail of all businesses.

Product-market fit is the degree to which a product satisfies a strong market demand.

Understanding the market the business operates in is crucial. Don’t invest if you don’t know the product trends, the typical prices, who the addressed audience is, the demographic and the psychographic, the major brands and their promises, the innovations and barriers to progress (legal or financial barriers for example) in that market.

Once you are confident you understand the company’s market, you should be able to figure if that company has a significant growth potential. Criteria may include:

  • The strength of the brand compared to its competition;
  • If the business has an unfair advantage (Warren Buffet calls this a moat);
  • How diversified the existing and future products are;
  • How innovative or forward looking the products are;

Because stock picking only makes sense when the stock actually grows a lot, if the business doesn't have a very strong potential for growth, I skip it. Even if I really, really love their products. Otherwise that’s not investing but it’s sponsoring. These are two very different things.

By the way, this is inversely true: you shouldn’t discard a company just because you don’t like or use their products. You don’t have to wear pantyhose to invest in a company that makes them. If the business has strong financials and it passes all your criteria, you should feel comfortable investing in it.

Vision and Ethics

This has less to do with Karma than with sustainability. A company that shows poor ethical guidance will eventually fail and your investment will be worth nothing.

A good place to start is the business’ vision. It’s usually promoted on their website and it’s fairly simple to figure, by looking at what the company does and by checking the news, if the company actually lives up to their vision.

I only invest in companies whose visions are in line with my ethics. This has not happened yet, but if I had invested in a company that I later found to be cheating or to be acting in a way that conflicts with my beliefs, I would like to think that even if the business would be very profitable, I would exit my position immediately.

When we invest in a stock, we basically provide the company behind it with some liquidity (even if at a small scale) that they will allocate to whatever they do. If that has negative impacts on the world, then we, as investors, are partially responsible for it.

I prefer investing in companies that output positive externalities, even if their return was to be slightly lower than a negative externality generating business. The thing with externalities is that they form a whole that either goes up or down. If you make sure your investments contribute to good, other good businesses and people may be able to thrive and produce indirect returns to your overall portfolio.

Take a long term, positive approach and invest in companies that do good.

It’s about increasing the size of the cake in some ways. Not playing a finite game.

By the way, this also applies to the company’s culture. If the business is helping a ton of people but at the same time mistreating or harassing their employees, it does not result in a long term net positive.

There is no going around making sure the company is taking care of its workforce and playing the infinite game. If they don’t, I won’t invest in it.

Executive Track Record

It’s easier than ever to find out about the C-level people at public companies. Just Google the company, browse their site, use LinkedIn… There are plenty of ways to see who is leading the business and what they have done in the past, for that company and for others.

This is important because without signs of past achievements, it’s very hard to be comfortable with the prediction of future successes.

Business is hard. Not everyone can be a good listed company leader and steer it towards success. Plans and expectations are destroyed all the time and executives need to be both reactive and proactive. Being open to change is harder said than done and delivering on a vision will require being able to adapt, over and over. That is the only way to consistently drive the stock to higher grounds (which is what we are looking for of course).

If a business has no one with proven past successes at its top (even if it is in a completely different field), I don’t invest in its stock. Until they do, if they do.

Closing Thoughts

This has been a useful way to find good businesses to invest in while feeling in agreement with my beliefs. I have for example debated with myself for a long time about investing in AAPL. They are huge, have an undeniable brand and their finances are stellar. However, I to my core disagree with their attitude towards the software market and so I never invested in their stock. And since much of their profitability and worth is drawn from that attitude, I don’t see that changing any time soon. Could I have made amazing returns by investing in that company years ago? No doubt. Do I regret not doing it? Not a single bit.