4 stock-picking tips for famous rappers like Soulja Boy

Deciding that it was time to diversify his assets, U.S. rapper Souljaboy recently asked his Twitter followers for stock tips:

Now, if you’re just starting out in investing, asking for advice is a great way to go. However it’s such a deep subject that 140 characters just isn’t going to cut it.

So I thought I would oblige Soulja Boy with some extended thoughts that I would give to anyone who was serious about building their wealth.

1. Don’t wipeout

It’s surprising how often you read stories of people who come into big money (lotto winners, rappers, footballers…), but wipeout and end up broke a few years later. You don’t want that, Soulja Boy.

Wipeouts are simple to prevent; avoid borrowing to invest; don’t put all your eggs in one basket; and if you don’t understand it, don’t invest in it.

People sometimes argue that concentrating a portfolio to just two or three businesses will increase returns when the companies do well. That can be true. But if you had pinned all your hopes on an energy company like Santos Ltd (ASX: STO) in 2014, your high-risk strategy is probably not serving you very well.

2. Look for companies with high returns on equity

Companies which produce high returns on shareholder equity have more ability to reinvest and grow over time, compounding shareholder wealth and paying out dividends. Industries with low returns on equity (ROE) are less preferable and best avoided.

Breathing device manufacturer ResMed Inc. (CHESS) (ASX: RMD) is a company listed in Australia and the U.S. which produces above average returns on equity and in my view has good long-term growth prospects.

3. Stress-test your opinions against the smartest people you can find

Before you put your money on the line, get a second opinion from the smartest people you can find to ensure you haven’t missed a risk because of bias or over-confidence.

This is an approach used by billionaire Ray Dalio who notes: “I stress-tested my opinions by having the smartest people I could find challenge them so I could find out where I was wrong”.

4. Compound, compound, compound

That’s your hook right there – “compound, compound, compound“, because that’s the part of investing that takes your wealth to a whole new level.

Just take a look at blood-product company CSL Limited (ASX: CSL). This is a company which over time a long period of time would have turned a $1,000 investment into over $200,000!

Compounding can feel painfully slow, but by reinvesting your dividends and taking advantage of dividend reinvestment plans, the cash can pile up faster and faster.

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Motley Fool contributor Regan Pearson has no position in any stocks mentioned. 

You can follow him on Twitter @Regan_Invests

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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