Today you’ll find out how to start investing in stocks.
When it comes to investing and trading, there are various novices who don’t understand the rules of the game and end up losing money, or significantly reducing their profit potential. Previous trends show that 80% of active traders lose money, while only 1% make money.
Investing eventually provides greater returns, but the average investor performs poorly in the market. The main reason is that many investors react to the market at the wrong time.
Without an informed perspective, many investors react to popular trends; buying stocks when the market is very optimistic, and then selling when they lose value as a result of pessimism.
As a smart investor, you need to have the ability to understand the company and industry you are investing in so that when the price goes down, you know enough about the company to know whether it will continue to go down, or simply be in a recession. This article will provide you with the tools to analyze any company in its industry and to understand its stock price fluctuations, guaranteeing optimal return on your investment.
How to Start Investing in Stocks:
Step 1: Identify Your Company
Before doing the next 8 steps, identify the companies you have an interest in. As an investor, you should see the company you invest in as one you would like to own. You should not even consider owning stocks if you have not thought about owning them for at least ten years.
Below are some of the main factors you need to consider when identifying your company. If you cannot answer yes to any of these questions, you should throw out your notebook and find another company to invest in.
Do you like the company? – When you are investing for the long term, you should choose a company that’s significant to you. This will make it easier for you to follow company announcements, feel more connected to the company’s vision, and will make it easier for you to hold onto your shares and make positive decisions during times of pessimism.
What services or products do they offer? – Do you understand the service or product the company offers? What is the target market? Is there a significant demand for this service or product?
How competent is the management team? – Find the company website and identify the directors and key managers. Look at the history of these managers and choose whether you’ll hire them to operate the company you own.
Does the company have a 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, update this information as you determine new factors affecting the strength of your company.
If your company’s strengths and opportunities significantly outweigh its weaknesses and threats, you should continue with the 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: Industry Analysis
Industry analysis is important for making informed investment decisions because every industry is different, providing many elements that influence competitive positioning. Porter’s Five Forces is a framework that helps analyze competition in an industry. By using Porter’s Five Forces to analyze industry components, your company’s competitive advantage can then be precisely determined.
1. Threat of newcomers – the potential for new competitors to enter the industry. High threat of new entrants can result in decreased profitability. Some of the barriers that can limit the threat of new entrants include brand loyalty, access to distribution channels, capital requirements, government policies, and product differentiation.
2. Bargaining power of suppliers – the supplier’s ability for the company to pressure it. High bargaining power can lead to a rise in inventory costs. Factors that affect the bargaining power of suppliers include switching costs, differentiation and substitute inputs, distribution channels and supplier competition.
3. Bargaining power of consumers – the customer’s ability to put the company under pressure. High bargaining power can lead to price reductions. Factors influencing this include the concentration of buyers, their dependence on available distribution channels, switching costs, and their price sensitivity.
4. Threat of substitute – the likelihood that the customer will switch to a substitute service or product. If the costs of switching to another service or product are low, and there are likely substitutes available, your company’s ability to increase prices will be limited.
5. Industry competition – the level of competition amongst existing firms in the industry. Increased competition can result in reduced profit potential. Some of the factors include competitive advantage through innovation, technology and strategic focus.
Once you have determined the factors affecting the industry’s competitive environment, analyze your company’s strategic position compared to its industry competitors. If your company does not have a competitive advantage, consider investing in one that does. If your company does have a robust competitive advantage in its industry then you are nearly guaranteed a stable investment.
Step 3: Brand Image and Marketing
The general impression that real or potential customers have a few company is a really significant factor in determining the chances of a company’s future success. Before investing in stocks, assess the following factors:
Company Vision – what’s the company’s vision? Do they share a shared vision with their target market? Are you in touch with this vision?
Marketing and Advertising – What type of marketing does the company have? How far is the company’s reach? Does it address the local or international market?
Public Perception – Find a company’s social media page and see how the company ranks, or what people are saying about them. Stay up to date with this information.
Aligned vision and good public perception indicate a robust company with its customer support and robust word-of-mouth referral potential. Assess a company’s reach and determine how effective their marketing strategy is, and how wide it’s spread. If a company’s marketing reach is limited, but they address a broad vision and target market, this suggests a large scope for future growth.
Step 4: Management
To be the team that leads your company to success or failure, you must identify who are the directors and bosses within your company. This step was covered in Step 1, but here you’ll analyze how managers help develop a company’s brand image and competitive advantage in its industry.
Look at management history. At which company did they work before? How successful have these companies been? What other positions do they currently hold?
Now that you have assessed the managers, you must also assess the perceptions of the company’s employees. As the backbone of a company, the workforce has an amazing influence on the company’s potential. What kind of employees does the company hire? Does this employee like working there? What competitive advantage can employees offer the company over competing companies? Do many employees have the same vision as the company?
If the management team does not have a robust reputation, and employees haven’t got a high perception of the company, you should consider investing in another company. The people working for the company are eventually the conduits that provide the customer experience, and it’s this experience that creates the brand image and competitive position.
Step 5: Define Value
Several components that can be considered to assess the value of shares include:
Price to Earnings Ratio – probably the most well-known ratios, the P/E ratio divides the share price by the earnings for each share. Stocks with lower P/E ratios perform better for their value based on company earnings, but irrespective of assets or growth.
Price-to-Book Ratio – The P/B ratio shows the value of every share compared 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 a sign of how a company is financing its assets, either through debt (such as loans or bonds), or equity (such as stocks).
Free Cash Flow – it suggests the actual cash position the company has after the capital investment.
Price/Earnings Ratio to Growth – The PEG ratio is an enhanced version of the P/E ratio that takes a company’s revenue growth into account. A better PEG ratio can be indicative of an undervalued, but growing company.
Intangible Assets – intangible assets include factors that provide increased value to the company, but aren’t listed in the metrics above. The company’s intellectual property assets, goodwill, brand image, management, and any other competitive advantages you may have identified between steps 1 and 4. These metrics are the most difficult to assess.
To determine the value of your company, you must assess all the above components based on the industry in which your company operates. Consider tangible metrics like PEG Ratio and P/B Ratio and determine the extra value that intangible metrics might offer. Once you have determined the value of your company’s shares, you can proceed to step 6.
Step 6: Wait and Buy
Once you have determined what each share in the company is worth to you, it’s time to wait for the shares to go on sale. Pay attention to economic cycles as outlined in the introduction. Consider whether the stock’s current price is discounted, 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 from the temporary losses you may face if you buy the stock at its peak before it crashes. If you are very optimistic about the company you invest in, it’s worth investing a small initial component (a percentage of your investment target value) so that you can maintain your position; then go to step 7. Remember to at all times set aside money for everyday expenses.
Step 7: Reinvest
Once you commit to your initial investment, time is your ally. You are now in a position where you’ll benefit from the market and any positive changes in the company itself, or to its share price. Maintain a constant assessment of the company’s competitive position in its industry together with the company’s brand image and management so that you can continue to understand the value of the company’s shares. Anytime a stock price underestimates, and you have funds to spend, you must reinvest to improve your position.
The hardest part about this step is having the ability to buy your stock while someone else is selling. This may be as a result of a wider economic crisis, in response to some media releases, or for many other reasons. When your stock does sell, the demand is also the least.
This means that sequentially, and often psychologically, it’s a really difficult decision to reinvest. The benefit you get is that, if you have done the previous steps, you’ll know if your company is still performing strong. Your goal in this step is to avoid reinvesting at the point of maximum risk (when the price increases) and instead to reinvest at the point of maximum opportunity.
Step 8: Diversify
You’ve most likely heard about the value of broad diversification and the role it plays in minimizing investor losses. The problem presented here, is the same thing to minimise the investor’s profit. The benefit is that you’re going to be well positioned to hold companies that have a robust competitive position within their industry, and will therefore be in a position for continued growth and exponential profits.
Provided, obviously, you have taken the time to research properly. What I’m suggesting here, rather than diversifying in a profit-limiting fund, is to diversify into a few different companies that have a significant competitive advantage.
Repeat the steps for a series of companies as you identify them, and diversify through companies backed by your investment knowledge. Warren Buffett’s diversification strategy incorporates a maximum of twenty companies, which he researches extensively every day. In his own words; “Broad diversification is only necessary when investors don’t understand what they are doing.”
The benefits of investing in individual companies that are competitively favored over a market spread (such as index funds) are easy. Index funds provide support by minimizing potential investment losses by holding positions above the index. When a company in the index loses value, the fund holds positions based on the profitability of other companies in the index.
Losses and profitability are averaged. By researching an industry and investing in many companies that have a competitive advantage, you’ll ensure a profitable position in the industry that won’t be undermined by holding an identical position in a less competitive company.
To diversify effectively, you must create your own diversification strategy. Decide what percentage of the portfolio you want to hold with each particular company. If you are having trouble deciding on this, have a look at some of the diversification strategies used by model investors, or talk to a financial advisor.
Step 9: Sell
Realistically, when making an investment, you should have no intention of selling. Unfortunately, however, situations do arise where this may be necessary. As a long term investor, rather than a trader, there are two main situations in which this might be appropriate:
1. Reallocate funds to fit your diversification strategy,
2. When your investment loses its intrinsic value.
Reallocating funds to fit your diversification strategy is an effective approach to maintaining a robust portfolio. Most notably, it makes for a robust portfolio by enabling you to stick to your investment strategy, avoiding potential emotional pitfalls.
Second, it lets you take advantage of points of maximum risk and maximum opportunity. Whenever a component of your investment portfolio is overvalued, and exceeds the planned percentage, you should reallocate these funds to another segment of your portfolio that’s undervalued.
Another reason to sell is if your investment has lost the intrinsic value you initially bought it for. If the company has changed in such a way as to eliminate the reason for your initial investment, it is a good time to sell and reinvest in a company that displays these attributes more closely.
This post will provide you with strategies to direct your learning in the right areas to generate strong returns on your investment. While the strategies outlined are stable, I suggest you seek financial advice to determine what investment scope best suits your personal goals. This article is targeted at young investors and may not be appropriate for investors who are nearing retirement age.
Thanks for reading this article on how to get started in stock investing and I actually hope you take my advice to heart. I wish you good luck and that I hope that its content has been a good help to you.