A beginner’s guide to stock investing
Stock codes, bid/offer, limit versus market orders… Welcome to the world of stock investing. Always exciting, sometimes a little unnerving, but necessary if you want to build long–term wealth.
But before you start, you need to begin with the end in mind. Yes, of course, the end is "to make money…". But there is an adjective missing at the end of that line. To make money "gradually". Or to make money "quickly"? If it's the latter, you could be setting yourself up for disappointment. However, if you're about building patient wealth over the course of your life with long-term goals—your children's education, a comfortable retirement—let’s start.
Step 1: Get the right mindset. Understand yourself
In general, there are three kinds of players in the market.
The long-term investor
This person understands that stocks—and markets in general—go through cycles. There are ups and downs. He or she buys good, buys at a reasonable price, and rides through the cycles. And "good" is the keyword here.
Understand the company you're buying into because a share is just that—a share in a company. A "good" company is one with good earnings, a sound balance sheet, competent and honest management, and a business that will likely still be around and thriving in 10, 20, 30 years. Pricing is a lot trickier. Prices fluctuate through cycles. But good companies' prices tend to mean revert around rising trend lines—that is up, down, up down, but over time, on higher highs and higher lows. That's how patient money is made.
On the other hand, the trader has to understand his skills, his resources and his limitations. If you have the time, the skill/experience, and the stomach for risk, by all means, take your fortunes in your own hands and trade. That is, buy and sell frequently, in the hope you profit overall. It's not easy. If it was, every trader would be Paul Tudor Jones (he is a chart-driven trader who made a fortune short-selling ahead of the Black Monday Crash of 1987 and was estimated last year by Forbes Magazine as being worth US$4.7 billion). Good luck, but there are not many Paul Tudor Joneses around.
Then there are investors who enter thinking they're long-term but take fright at market declines and sell. There are those who are tempted into rapidly rising stocks, without understanding the fundamentals (or the lack of fundamentals) of those stocks. These are the victims of the trade. That's a recipe for "buy high, sell low" disasters.
Step 2: Pick a dealer or go digital?
Next, do you want to do this through dealer–assisted trades? Or through online systems? If you don’t mind paying higher commissions for somebody to help, go for the dealer-assisted method. On the other hand, digital platforms are cheaper, more convenient, offer fundamental research and sometimes even charting facilities which you carry with you everywhere, available anytime.
Then there is the choice of online brokers. Consider the reputation and the track record of the broker. The security of your funds and the reliability of the system in handling your trades depend on this. Strike a balance between quality/reputation and the brokerage commissions charged.
Step 3: Evaluate your target companies before you invest
Understand the income statement
Is the company making earnings/profits? What are analysts’ forecasts of its future earnings? The value of any asset is in the stream of future earnings that the asset produces for its owners. If it’s not making any earnings, you are speculating that it will turnaround and make earnings soon. Or that somebody will buy out the asset to turn it around. So, it’s speculative. And if it has been making earnings, what are the analysts saying about its prospects of continuing to make earnings in the future? That’s what you’re paying for.
Look at the cash flow
How is the company’s cash flow? Companies can be generating apparently good accounting profits but be considerably weaker in cash flow terms. In certain extremes, a company can get into financial trouble even if it is reporting accounting profits but not generating enough cash flow to meet commitments.
Understand the balance sheet
There are a whole bunch of indicators of balance sheet health. Understand them. They include the debt to equity ratio, the current ratio, and the liquid ratio/acid test ratio. They are critical indicators of financial health of the company. And these are topics to explore in more detail in another article. For now, you can usually get a fair bit of insight reading the research on companies offered by a good online broker.
Step 4: Understand the online system, the trade terminology and processes
The only thing worse than a poor trade is an error trade. At least in the former, you bungled on the analysis of the stock rather than an error of a key stroke. It’s not something the ‘Undo’ shortcut can help you with, unfortunately.
Step 5: Start investing
If you’ve survived till the end of this article and feel excited about learning more, congratulations. However, if the hard work mentioned above is putting you off, then you might want to reconsider investing directly into equities. The better option might be to buy a unit trust managed by an asset management company with a good track record.
There is so much more to talk about. And there is no instant, immediate guide to good investing. It is a lifelong learning process. And it begins with your first trade.