"I think this company is going to make a killing..."
My brother, an acute businessman and owner of a construction firm, recently told me he was thinking of putting a few grand into a small, relatively unknown company. It trades over-the-counter and sells workout powders, like whey protein.
I was familiar with the company and its products. My brother and I even knew one of the founders.
But it didn't take me long to prove that this was a bad investment.
I asked my brother, "Would you go into business with this guy on a housing project?"
"Absolutely not," he said, almost immediately. "The guy was sued by the Food and Drug Administration in his previous endeavor, and he isn't someone that I would want to partner with... ever."
It's a funny thing. My brother understands real estate, construction -- business, in general. But throw him a ticker symbol, and his judgment is clouded. Instantly, everything he knows about business is forgotten, and he acts like a tourist at a Vegas roulette table, slapping a few grand on 30-red.
Posing that simple question to my brother deterred him from buying shares. Later on, a lawsuit was brought against the company, in addition to a handful of others, for cutting protein supplements with cheap fillers and falsely labeling them as high-grade protein. Some products contained only 19 of the 50 grams of protein the packaging listed.
The stock plummeted more than 50% following the news.
Why Most Investors Will Never Get Rich In The Stock Market
Here's what my brother failed to understand...
Buying one share of a company is the same as a co-venture on a construction project, but on a smaller scale. You are buying a piece of that firm.
Sadly, he's not alone. In, fact the majority of investors fail to understand that owning a stock puts you in business with management. You are trusting that they're competent, savvy and -- most importantly -- not going to screw you over.
If you want to invest in a company and make money in the process, then you need to build a deep understanding of the business, its market, its management, any headwinds that might slow it down and any tailwinds that could propel it higher.
Put simply, successful investors understand the businesses that they buy. Too often, average investors become mesmerized by the market's hysteria in search of the one winner that will rain money on them for life. Instead of being an investor, most people, in actuality, are traders with poor execution. They buy stocks they don't understand, at unreasonable prices, and when the trade turns south, they sell low.
That is why the majority of investors will never get rich in the stock market.
Action To Take
I don't tell you this to scare you away from looking for new investments. On the contrary, familiarizing yourself with new companies in various industries is a great way to diversify your portfolio and limit your overall exposure to the stock market.
But before I ever buy shares of a stock, I tear apart the company. I analyze its financials, familiarize myself with the management team and construct a list of headwinds, tailwinds and future expectations. Only once it's won my approval do I recommend a security to my readers. Like the lesson I taught my brother, I don't ever want to partner with a company I don't understand.