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How to invest like a business owner

January 09, 2015

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Investing Your Own Money

People tend to view investing as different from their personal business experiences. But if you have ever run or helped manage a company, you may find parallels between making sound business decisions and successfully managing an investment portfolio.

Here are four management principles that also apply to buying and selling stocks.

1. Entrepreneurs are hard to replicate

For business owners, handing over the reins to the next generation of leaders is always difficult. Besides being emotionally wrenching for a company's founders, the transition can be tough because the next stage of a company's life cycle may call for a different skill set than the first stage. Succession planning should be about putting people in place who are the right fit for the future, rather than about trying to recreate the past.

For investors, that transition from a founder to the subsequent leader can be a rocky time to own a stock. Do not get too caught up in the cult of personality around a charismatic leader -- concern yourself more with whether the supporting team is strong enough. In particular, if a company founder resorts to passing the baton on to a relative, shareholders need to take a hard look at whether that is objectively the best thing for the company.

2. It's better to overpay for a good investment than get a bad one for cheap

For business owners, acquisitions tend to be primarily about the operational capability or market access. Pricing is tricky in private markets, but a good business choice is likely to pay for itself in the long run.

For investors, the challenge is somewhat reversed. After all, if you own a portfolio of 30 or 40 stocks, you can't be intimately familiar with all their business details. It is easy, even formulaic, to focus on pricing instead, but beware of buying a stock simply because it has gotten cheaper. Sometimes there is a good reason the price is falling.

3. Diversification is not always a good thing

For business owners, it can be a costly mistake to venture outside the organization's core competencies. Too many companies distract themselves with cycles of diversification followed by divestiture.

For investors, the message is to beware companies that are trying to do to many things at once. As with individuals, multitasking for corporations often means doing two or more things poorly at the same time.

4. Growth is hard to maintain

For business owners, the trick is knowing when growth brings economies of scale, and when the opposite is true. Especially in talent-based businesses, too much growth can result in a dilution of the product or service they provide.

For investors, the price you pay for a stock will be based on its growth prospects. Don't be seduced by past growth rates, because the bigger a company gets, the harder it is to maintain a high rate of growth.

Business managers are generally acutely aware of their own companies' opportunities and risks. Putting yourself in the shoes of company management for the stocks you own can help you gain perspective on the opportunities and risks of those companies, and lead you to better investment decisions as a result.

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