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How to Stay Out Of Trouble in the Stock Market

Life is often full of contradictions and this applies to the stock market too. How so? Try this: The stock market is a marvelous place to build lasting long-term wealth; yet, it is also full of landmines that can blow up in your face.

A great example of this landmine-prevalence is found in a recent study of the U.S. stock market done by J.P. Morgan:

  1. Nearly 40% of all stocks in the Russell 3000 (an American share market index comprised of the largest 3,000 U.S. companies) universe since 1980 have suffered a permanent decline of more than 70% from their peak value.
  2. Since 1980, 40% of all stocks in the Russell 3000 universe have delivered negative absolute returns over their entire lifetime as a publicly-listed entity (the “lifetime” returns of a share start from the date of its listing all the way till 2014 or the date at which it ceased to be a listed entity).

Steve Jobs of Apple Inc. fame once said, “Deciding what not to do is as important as deciding what to do.” Investors have to appreciate that wisdom in order to get a great experience out of the stock market’s contradiction – by avoiding the landmines, what’s leftover can provide the sturdy bricks that build lasting wealth.

How can investors avoid the landmines though? The key word here is process. Having a sound investment process can do wonders for an investor.

When the penny-stock trio of Blumont Group Ltd (SGX: A33), LionGold Corp Ltd (SGX: A78), and Asiasons Capital Limited (SGX: 5ET) blew up in October 2013 after experiencing rapid price increases, I wrote a number of articles on the lessons investors can learn from the saga (see here and here).

There was a reader though, who pointed out that everything I was writing about was purely in hindsight. He mentioned that neither I nor my colleagues had highlighted any problems that may be brewing with the trio before they collapsed.

Problem is, I didn’t even knew those three companies existed prior to their stunning collapse – and that had a lot to do with my investing process.

My process consists of filters (built upon business-characteristics and valuation figures which I find desirable) and conversations with other individual investors whom I consider to be really intelligent (this group includes my colleagues at The Motley Fool Singapore as well).

With that, shares like Blumont, LionGold, and Asiasons would never show up as potential investing opportunities because they neither possessed the business-characteristics I was looking out for (things like strong returns on equity on an unlevered balance sheet, a history of innovation, and a track record of being able to attack a growing and massive market) nor the valuation figures I would have deemed to be prudent (Blumont and Asiasons were valued at more than 500 times their trailing earnings at one point prior to their massive share price falls!).

It’s not that my process would save me from ever committing any mistakes – in fact, if there’s one thing I’m 100% certain of in the investing word, it’s that every investor will be making mistakes at some point or another over time. The key though, is to ensure that the mistakes are heavily out-weighed by the correct decisions. That’s where having a sound investment process can help.

A Fool’s take

The stock market can be treacherous. But as individual investors, there are things we can do to stay well-clear of such treachery. By building a sound investment process, we can stay out of trouble in the stock market.

For more investing analyses and important updates about the stock market, sign up to The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Apple Inc.