4 rules to remember if you want to be a top investor

When you sit back and really take in what all the top investors around the world recommend, it’s amazing how similar the rules are. The best long-term investors rely on a few simple rules:

  1. Buy under market value
  2. Buy only quality companies
  3. Avoid speculative bets on tiny companies
  4. Do the opposite of the crowd

You can find interviews with spectacularly successful investors all over the internet, but a recent interview with Anton Tagliaferro of Investors Mutual by the analysts at Morningstar revealed four lessons that all Foolish investors should remember.

Rule 1: Understand the difference between speculation and investing

You should only invest in a company if it passes your benchmark of value. This could include a combination of price to earnings ratio, earnings growth rate, intrinsic value, or any other metric, however the most important thing is that a company is compared to these metrics before buying. In this way an investor can measure his or her success based on the suitability of these metrics.

The way that far too many people lose money in the share market is by buying a handful of micro-cap stocks that uncle Bob thinks will go ok, but all too often turn out to be duds (this is speculating). A good example of this is Lynas Corporation Limited (ASX: LYC).

Rule 2: Understand the difference between value and market momentum

This follows from point 4 above. If a company is on ‘sale’ then buy some (based on your perception of value), however if it is well above the price that you consider to be the value of the company, be cautious.

The market may push up the share price of a popular company like Liquefied Natural Gas Ltd (ASX: LNG), but that doesn’t necessarily make it a great investment at the current price.

Rule 3: Understand the difference between information and knowledge

Mr Tagliaferro notes that it is becoming ever more difficult to achieve an unbiased view on a company due to the endless amounts of analysis written every day. Large cap companies like BHP Billiton Limited (ASX: BHP) have so much research written about them that it’s worth spending time to be sure on your own point of view.

Rule 4: Understand the difference between perception and reality

Mr Tagliaferro notes that market commentators have a great ability to influence the masses. He uses the example of the 2000 tech boom, where some companies were valued based on ‘new’ metrics and ended up being very expensive compared to companies that were valued using ‘old’ metrics.

The end result, as many will be aware, is that many of these companies crashed into oblivion, but the companies in value using the ‘old’ metrics are still around today. Consider the staying power of massive names like CSL Limited (ASX: CSL), Brambles Limited (ASX: BXB) or Amcor Limited (ASX: AMC).

At the end of the day though, many investors just don’t have the time to do this type of research. The Motley Fool can help! Here’s an example of what we can provide to time-poor investors:

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Motley Fool contributor Andrew Mudie does not own shares in any companies mentioned. You can find Andrew on Twitter @andrewmudie

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