Today you’re going to learn how to start investing in stocks.
When it comes to investing and trading, there are many beginners who do not understand the rules of the game and end up either losing money, or significantly reducing their potential gains. Past trends have indicated that 80% of active traders lose money, while only 1% make money.
Investing ultimately gives greater returns, yet the average investor underperforms the market. The main reasons for this is that many investors react to the market at the wrong time.
Without an informed perspective, many investors react to popular trends; buying shares when the market is very optimistic, and then selling when the share loses value in a bout of pessimism.
As an intelligent investor, you need to be able to understand the companies and industries that you invest in so that when the price falls, you know the company well enough to understand if it will continue to fall, or is only in recession. This article will give you the tools to analyze any company within its industry and to understand the price fluctuations of its stocks, ensuring optimal profit from your investments.
How To Start Investing In Stocks:
Step 1: Identify Your Company
Before going through the next 8 steps, identify a company that you are interested in. As an investor, you should look at any company you invest in as one you want to own. You shouldn’t even consider owning a stock if you aren’t thinking of owning it for at least ten years.
Below are some of the main factors that you will need to consider when identifying your company. If you cannot answer yes to any of these questions, you should throw away your notebook and search for another company to invest in.
Do you like the company? – As you are investing for the long term, you will need to choose a company that means something to you. This will make it easier for you to keep up to date with company announcements, feel more connected to the company’s vision, and will make it easier for you to hold onto the stock and make positive decisions during times of pessimism.
What product or service do they offer? – Do you understand the product or service that the company offers? What is the target market? Is there significant demand for this product or service?
How competent is the management team? – Locate the company’s website and identify the main directors and managers. View the history of these managers and determine if you would hire them to operate a company you own.
Does the company have competitive advantage? – Draw a SWOT chart in your notebook and write down the strengths, opportunities, weaknesses, and threats that may affect your company. As you progress through the rest of this post, make updates to this informations as you determine new factors that affect the strength of your company.
If the strengths and opportunities of your company significantly outweigh the weaknesses and threats, you should continue with the following eight steps of this post.
Does the company have room for growth? – What is the company’s target market? Is there significant room for future development?
Step 2: Analyze the Industry
An industry analysis is important for making informed investment decisions as each industry is different, providing a multitude of elements that affect competitive positioning. Porter’s Five Forces is a framework that helps analyze competition within an industry. By using Porter’s Five Forces to analyze the components of the industry, your company’s competitive advantages can then be accurately determined.
1. Threat of new entrants – the potential for new competitors to enter the industry. A high threat of new entrants can result in decreased profitability. Some barriers that can limit the threat of new entrants include brand loyalty, access to distribution channels, capital requirements, government policy, and product differentiation.
2. Bargaining power of suppliers – the ability for the suppliers for the company to put it under pressure. A high bargaining power could lead to an increase in the cost of supplies. Factors that impact the bargaining power of suppliers include switching costs, differentiation and substitute inputs, distribution channels, and supplier competition.
3. Bargaining power of customers – the ability for customers to put the company under pressure. A high bargaining power could lead to reduced prices. Factors impacting this include buyer concentration, their dependency on the distribution channels available, their switching costs, and their price sensitivity.
4. Threat of substitutes – the likelihood that a customer will switch to a substituted product or service. If the cost to switch to another product or service is low, and there are possible substitutes available, the ability for your company to raise prices will be limited.
5. Industry rivalry – the degree of competition amongst existing companies within the industry. Increased competition can result in reduced potential for profits. Some factors include competitive advantage through innovation, technology, and strategic focus.
Once you have determined factors affecting the competitive environment of the industry, analyze your company’s strategic position in comparison to its industry rivals. If your company does not hold a competitive advantage, consider investing in one of the companies that does. If your company does hold a strong competitive advantage within its industry, then you are almost guaranteed a stable investment.
Step 3: Brand Image and Marketing
The general impression that real or potential customers hold about a company is a very significant factor to determining a company’s chance for future success. Before investing in a stock, assess the following factors:
Company Vision – what is the company’s vision? Do they share a combined vision with their target market? Do you relate to this vision?
Marketing and Advertisement – What kind of marketing does the company have? How far is the company’s reach? Does it address a localized or international market?
Public Perception – Locate the company’s social media pages and see what the company’s ratings are, or what people say about them. Keep up to date with this information.
An aligned vision and good public perception indicates a strong company with the support of its customers and strong potential for word of mouth referrals. Assess the reach of the company and determine how effective their marketing strategy is, and how wide spread it is. If the company’s marketing reach is limited, yet they address a broad vision and target market, this is indicative of great room for future growth.
Step 4: Management
Being the team that leads your company into success or failure, you should identify who the directors and managers are within your company. This step has already been touched upon in Step 1, yet here you will be analyzing how the managers help develop the brand image and competitive advantage of the company within its industry.
Look at the managements’ history. What previous companies have they worked at? How successful were these companies? What other positions do they currently hold?
Now that you have assessed the managers, you should also assess the perception of the company’s employees. As the backbone of a company, the workforce has a great impact on the company’s potential. What kind of employees does the company hire? Do these employees like working there? What competitive advantage could the employees offer the company over competing companies? Do many of the employees share the same vision as the company?
If the management team does not hold a strong reputation, and employees do not hold a high perception of the company, you should consider investing in a different company. The people that work for a company are ultimately the conduit that provides an experience for customers, and it is this experience which will create brand image and competitive positioning.
Step 5: Determine Value
Several components that can be considered for assessing the value of a stock include:
Price-to-Earnings Ratio – one of the best-known ratios, the P/E ratio divides the share price by the earnings for each share. A stock with a lower P/E ratio has a greater performance for its value based off the company’s earnings, yet does not consider assets or growth.
Price-to-Book Ratio – the P/B Ratio indicates the value of each share in comparison to the company’s tangible assets. A low P/B ratio can indicate an undervalued company, with a P/B of 1.5 or less indicating solid value.
Debt-Equity – this measure gives an indication of how the company has finances its assets, whether through debt (such as loans or bonds), or equity (such as shares).
Free Cash Flow – this advises of the actual cash position a company holds after capital investments.
Price/Earnings to Growth Ratio – the PEG Ratio is an enhanced version of the P/E ratio that considers the earnings growth of the company. A better PEG Ratio can be indicative of a company that is undervalued, but growing.
Intangible Assets – intangible assets include factors that provide increased value to a company, yet are not listed in any of the above metrics. These assets corporate intellectual property, goodwill, brand image, management, and other competitive advantages you may have identified between steps 1 and 4. This metric is the most difficult to assess.
To determine the value of your company, you should assess all the above components based off the industry that your company operates within. Consider the tangible metrics such as the PEG Ratio and P/B Ratio, and then determine what additional value the intangible metrics may offer. Once you have determined the value of your company’s shares, you can then move on to step 6.
Step 6: Wait and Buy
Once you have determined what value each share in a company holds for you, it is time to wait for the stock to go on sale. Take in mind the economic cycle as outlined in the introduction. Consider if the current share price is a discount, of relative value, or overpriced. If the price exceeds your valuation, then wait for it to hit a correction, or even a bear market, before investing.
This will save you the temporary loss you may face if you purchase the stock at its peak before it falls into a trough. If you are very optimistic about the company that you are investing in, there is merit in investing a small initial component (a percentage of your target investment value) so that you have hold on a position; then proceed to step 7. Remember to always leave money in reserve for daily expenses.
Step 7: Reinvest
Once you have committed to your initial investment, time is your ally. You are now in a position where you will profit from the market and any positive changes within the company itself, or for the price of its stock. Keep a constant assessment of the company’s competitive positioning within its industry along with the company’s brand image and management so that you can keep an ongoing understanding of the value of the company’s shares. Whenever the shares are undervalued, and you have the finances to spend, you should reinvest to increase your position.
The hardest part of this step is to be able to buy your stock when everyone else is selling. This may be because of broader economic crisis, in response to some media release, or for a multitude of other reasons. When your stock is truly on sale, it is also in the least demand.
This means that it is sub sequentially, and often psychologically, a very difficult decision to reinvest. The benefit that you have is that, if you have taken the previous steps, you will know if your company is still performing strongly. Your goal within this step is to avoid reinvesting at the point of maximum risk (when prices are inflated) and rather to reinvest at the point of maximum opportunity.
Step 8: Diversify
You may have heard about the value of wide diversification and its role in minimizing an investor’s losses. The problem that this presents, is that it does the same for minimizing an investor’s profits. The benefit is that you will be well positioned to hold a company that holds a strong competitive positioning within its industry, and therefor will be in a position for continued growth and exponential profit.
Provided, of course, that you have taken your time to research properly. What I suggest here, is rather than diversifying in profit limiting funds, diversify into a few different company’s that hold significant competitive advantage.
Repeat the steps for a series of companies as you identify them, and diversify through companies supported by your invested knowledge. Warren Buffett’s diversification strategy incorporated a maximum of twenty companies, about which he researched extensively daily. In his own words; “Wide diversification is only required when investors do not understand what they are doing”.
The benefit of investing in individual competitively advantaged companies over a market spread (such as an index fund) is simple. An index fund provides support by minimizing the potential losses of an investment by holding a position over the index. When a company in that index loses value, the fund holds a position based off the profitability of other companies in the index.
The losses and profitability are averaged out. By researching into an industry and investing in multiple companies that hold a competitive advantage, you will ensure a position on profit within the industry that won’t be brought down by holding a similar position on less competitive companies.
To effectively diversify, you should create your own diversification strategy. Decide what percentage of your portfolio you want to hold with each specific company. If you are having difficulty deciding this, have a look at some of the diversification strategies employed by model investors, or speak to a financial advisor.
Step 9: Sell
Realistically, when establishing an investment, you should not have the intention to sell. Unfortunately, however, situations do arise where this may become necessary. As a long-term investor, rather than a trader, there are two main situations in which this may become appropriate:
1. Reallocating funds to match your diversification strategy,
2. When your investment loses its intrinsic value.
Reallocating funds to match your diversification strategy is an effective approach to maintaining a strong portfolio. Predominantly, it generates a strong portfolio by enabling you to maintain your investment strategy, avoiding the potential for emotional pitfalls.
Secondly, it enables you to capitalize on the points of maximum risk and maximum opportunity. Whenever a component of your investment portfolio becomes overvalued, and exceeds your planned percentage, you should reallocate these funds into another segment of your portfolio that is undervalued.
The other reason to sell would be if your investment has lost the intrinsic value for which you initially purchased it. If the company has changed in a way that has removed the reasons for your initial investment, it is a good time to sell and reinvest in a company that more closely displays these attributes.
This post will give you the strategies to direct your learning into the right areas to generate strong returns from your investments. While the strategies outlined are stable, I suggest that you seek financial advice to determine what scope of investments best suit your personal goals. This article is targeted at young investors and may not best suit an investor close to his or her retirement age.
Thank you for reading this article about how to start investing in stocks and I really hope that you take action my advice. I wish you good luck and I hope its contents have been a good help to you.