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The five rules for successful stock investing Part 5

So far, we've spent all of our time analyzing companies. If the investment process were as simple as identifying great companies with shareholder - friendly management teams and wide economic moats | 9 Valuation The Basics So FAR we ve spent all of our time analyzing companies. If the investment process were as simple as identifying great companies with shareholderfriendly management teams and wide economic moats we d be finished and investing would be much easier. But even the most wonderful business is a poor investment if purchased for too high a price. To invest successfully means you need to buy great companies at attractive prices. This is an idea that lost credence during the bull market of the 1990s and was thrown completely out the window during the tech bubble. Valuations mattered less and less because investors were always willing to pay more and more in fact one popular investment commentary service stated baldly that business quality was 100 times more important than valuation. For a while this strategy relying on a greater fool to take an asset off your hands at a higher price was lucrative and made many people rich at least on paper. The trouble was that no one knew when the music would stop. When it did investors who bought overpriced assets hoping to sell them at even more inflated prices were sorely disappointed. This is the difference between investors and speculators. Investors purchase an asset for less than their estimate of its value and receive a return 126 VALUATION---THE BASICS more or less in line with the financial performance of that asset. Speculators by contrast purchase an asset not because they believe it s actually worth more but because they think another investor will pay more for it at some point. The return that investors receive on assets depends largely on the accuracy of their analysis whereas a speculator s return depends on the gullibility of others. Over time the stock market s returns come from two key components investment return and speculative return. As Vanguard founder John Bogle has pointed out the investment return is the appreciation of a stock because of its dividend yield and subsequent earnings growth .