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104-What Matters and What Doesn't [Morning Start]
  Course 104:
  What Matters and What Doesn't
  Different people have different notions of what stock investing is all about.
  Before we go any further, we want to put things into focus and set you on the
  right path.
  
  
  Investing Does Not Equal Trading
  Your perception of stock investing may involve highly caffeinated, frantic
  traders sweating in front of a half dozen computer screens packed with
  information, while phones ring off the hook in the background.
  
  Feel free to dump these images from your mind, because solid stock investing
  is not about trading, having the fastest computers, or getting the most
  up-to-the-second information. Though some professionals make their living by
  creating a liquid market for stocks, actively "day trading" is simply not how
  most good investing is done by individuals.
  
  Beyond having to expend an incredible amount of effort to track stocks on an
  hour-by-hour basis, active day traders have three powerful factors working
  against them. First, trading commissions can rack up quickly, dramatically
  eroding returns. Second, there are other trading costs in terms of the bid/ask
  spread, or the small spread between what buyers are bidding and sellers are
  asking at any moment. These more hidden frictional costs are typically only a
  small fraction of the stock price, but they can add up to big bucks if
  incurred often enough. Finally, frequent traders tend not to be tax efficient,
  and paying more taxes can greatly diminish returns.
  
  Just as someone can be a great racecar driver without being a mechanical
  engineer, you can be a great investor without having a clue about how the
  trades actually get executed in the market. How your orders flow from one
  computer system to the other is of little consequence.
  
  Just remember that investing is like a chess game, where thought, patience,
  and the ability to peer into the future are rewarded. Making the right moves
  is much more important than moving quickly.
  
  
  Investing Means Owning Businesses
  If the mechanics of actual trading mean little, what does matter? Do charts of
  stock prices hold the answers? We've said it once, and we'll say it again and
  again: When you buy stocks, you are buying ownership interests in companies.
  Stocks are not just pieces of paper to be traded.
  
  So if you are buying businesses, it makes sense to think like a business
  owner. This means learning how to read financial statements, considering how
  companies actually make money, spotting trends, and figuring out which
  businesses have the best competitive positions. It also means coming up with
  appropriate prices to pay for the businesses you want to buy. Notice that none
  of this requires lightning-fast reflexes!
  
  You should also buy stocks like you would any other large purchase: with lots
  of research, care, and the intention to hold as long as it makes sense. Some
  people will spend an entire weekend driving around to different stores to save
  $60 on a television, but they put hardly any thought into the thousands of
  dollars they could create for themselves by purchasing the right stocks (or
  avoiding the wrong ones). Again, investing is an intellectual exercise, but
  one that can have a large payoff.
  
  
  You Buy Stocks, Not the Market
  We've all seen the prognosticators on television, predicting where the market
  is going to go in the future. One thing to remember when listening to these
  market premonitions is that stock investing is about buying individual stocks,
  not the market as a whole. If you pick the right stocks, you can make money no
  matter what the broader market does.
  
  Another reason to heavily discount what the prognosticators say is that
  correctly predicting market movements is nearly impossible. No one has done it
  consistently and accurately. There are simply too many moving parts, and too
  many unknowns. By limiting the field to individual businesses of interest, you
  can focus on what you can actually own while dramatically cutting down on the
  unknowns. You can save a lot of energy by simply tuning out market
predictions.
  
  We established in the previous lesson that stocks are volatile. Why is that?
  Does the value of any given business really change up to 50% year-to-year?
  (Imagine the chaos if the value of our homes changed this much!) The fact is, 
  "Mr. Market" tends to be a bit of an extremist in the short term,
  over-reacting to both good and bad news. We will talk more about this
  phenomenon later, but it is nevertheless a good fact to know when starting.
  
  
  Competitive Positioning Is Most Important
  Future profits drive stock prices over the long term, so it makes sense to
  focus on how a business is going to generate those future earnings. At
  Morningstar, we believe competitive positioning, or the ability of a business
  to keep competitors at bay, is the most important determining factor of future
  profits. Despite where the financial media may spend most of its energy,
  competitive positioning is more important than the economic outlook, more
  important than the near-term flow of news that jostles stock prices, and even
  more important than management quality at a company.
  
  It may be helpful to think of the investing process as if you were planning a
  trip across the ocean. You cannot do anything about the current weather or the
  tides (the current economic conditions). You can try to wait out bad weather
  that might sink your ship, but then you are also giving up time. And as we've
  already covered, time is a precious resource in investing.
  
  The main thing you can control is what ship to board. Think of the
  seaworthiness of a ship as the competitive positioning of a business, and the
  horsepower of the engine as its cash flow. Some ships have thick, reinforced
  metal hulls, while others have rotting wood. Clearly, you would pick the ships
  that are the most seaworthy (with the best competitive positioning) and have
  the most horsepower (cash flow).
  
  Though the ship's captain (company management) certainly matters, the quality
  of the ship is more important. On a solid vessel, as long as the captain does
  not mess up, there is not much difference between a good and a great captain.
  Meanwhile, there is nothing the best skipper can do if the boat's engine is
  broken and the boat is constantly taking on water (poor business). To relate
  this to stocks, business economics trump management skill.
  
  It's also worth noting that all ships will experience waves (volatility). And
  though it is true that a rising tide lifts all ships, the tides have nothing
  to do with the quality of the boats on the sea. All else equal, a better ship
  is still going to arrive faster, and a company with the best competitive
  positioning is going to create the most value for its shareholders. We will
  talk about exactly how to spot the best ships in later lessons.
  
  
  The Bottom Line
  It is very easy for new stock investors to get started on the wrong track by
  focusing only on the mechanics of trading or the overall direction of the
  market. To get yourself in the proper mind-set, tune out the noise and focus
  on studying individual businesses and their ability to create future profits.
  In the coming lessons, we will begin to build the skills you will need to
  become a successful buyer of businesses.