The basic principle of investing is that investors are looking to make a return on an investment. The way that this occurs is that a stock is bought at a low price, and sold at a higher price in the future. This is as basic a description as could be given, but it shows clearly that what investors are really doing is searching for an undervalued stock, with the hope that the market will identify the correct value and allow the investor to realize the true value of the stock. Undervalued stocks aren’t just sitting around ready for the buying however – if they were, there would be demand and the price would rise! So the art of investing is really to know how to identify a stock that is selling below its true value, and capitalize on that knowledge.
Learning to identify an undervalued stock requires an investor to be in tune with market cycles, and act with courage when they find an opportunity. For example in the last 6-9 months, the global financial crisis saw the share price of most banks tumbling, by more than 50% in some cases. Anyone buying at that time might have doubled their money by now – an incredible return. Of course, buying shares in the middle of a huge market crash requires nerves of steel – but you can bet that the big boys were doing just that.
More general principles to identify a good buy are to get to know the company well. Get familiar with their financial situation, their history, assets, and debts. Think realistically about their products or services, and consider whether their target market might grow over time for some reason – maybe they produce a component required for a new technological innovation? All of these factors can help you make an informed decision, and can be the difference between healthy profits and stagnation or worse.