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Ignoring Valuation
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This one came back to haunt many people over the past few years. Although it's certainly possible that another investor will pay you 50 times earnings down the road for the company you just bought for 30 times earnings, that's a very risky bet to make. Sure, you could have made a ton of money in CMGI or Yahoo! during the Internet bubble, but only if you had gotten out in time. Can you honestly say to yourself that you would have?

The only reason you should ever buy a stock is that you think the business is worth more than it's selling for—not because you think a greater fool will pay more for the shares a few months down the road.

We'll talk a lot more about the concept of intrinsic value and valuation more in Chapters 9 and 10. For now, just remember that the best way to mit­igate your investing risk Is to pay careful attention to valuation. If the market's expectations are low, there's a much greater chance that the company you purchase will exceed them. Buying a stock on the expectation of positive news flow or strong relative strength is asking for trouble.

Relying on Earnings for the Whole Story

At the end of the day, cash flow is what matters, not earnings. For a host of reasons, accounting-based earnings per share can be made to say just about whatever a company's management wants them to, but cash flow is much harder to fiddle with. The statement of cash flows can yield a ton of insight into the true health of a business, and you can spot a lot of blowups before they happen by simply watching the trend of operating cash flow relative to stock trading earnings. One hint: If operating cash flows stagnate or shrink even as earnings grow, it's likely that something is rotten.

We'll talk more about the importance of analyzing cash flow in Chapters 5 and 6 and I'll show you how to use it to detect potential accounting problems in Chapter 8.

If you can avoid these common mistakes, you'll be miles ahead of the average investor. Now, let's move from what you shouldn't do to "what you should do. In the next chapter, I'll show you how to separate great companies from average ones by analyzing economic moats.

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