We have all heard the basics of investing over and over: You have to start early, you need to be diversified, you need to take advantage of your 401(k), and so forth. Those are good tips and should be heeded, but they do little to help you with your investing knowledge or your success as an investor, whether you’re a rookie, a dilettante or a seasoned stock market veteran.
First, let me say that investing in the stock market is not without its risks. Before going “all in,” you should consider some lower-risk and more stable investments, such as mutual funds or index funds. When you enter the world of investing, it is wise to always have an emergency fund and to recognize that any money that you play the market with can disappear.
So, with the standard disclaimer out of the way, here are a few overlooked investing basics that can benefit investors of all levels.
Buy and sell, but don’t hold
When it comes to stocks, you are buying, selling or holding. Sometimes, these stances are referred to in vague terms, such as “underperform” or “overweight.” Nonetheless, you can boil them down to the same basic three, which are indicative of action and decisiveness. Once you have made a commitment to investing, lying in the weeds -- or holding -- will only make you susceptible to fear and greed, which may hinder your chances of success. It is best if you develop a course of action and stick to it.The reality of investing is such that you should always be buying or selling -- never holding. The only reason to invest in a stock is because you feel it will go up, and if it is going up, make a point to buy more. Sure, you may have to wait for your next paycheck to have some extra money available, but as long as the prospects are good, take action and give yourself more upside opportunity. Conversely, if your investment looks sour, it’s best to move on and sell your position -- even at a small loss -- rather than sweat it out and watch your stash slowly deteriorate. Once you have committed to investing in a stock, buy it -- do not wait for a ”better” price that may never come.
Act like an owner
When you buy stock, you become part owner of the company that you’re investing in, a fact that is often forgotten. A famous quote from Warren Buffet is particularly suitable here: “Buy a business, do not rent stocks.”Ask yourself the same types of questions you would as a business owner when you’re investing in stocks. Such as: Is the stock treating you the way you would treat yourself as an owner? Does the business make a good product? How does it stack up against the competition? Does the business make money?
Nobody goes into business to lose money, so when you start investing, you should have the same mentality and act accordingly. Granted, you won’t be running the day-to-day operations of the company, but that doesn’t mean you shouldn’t think that you do. Take a look at the statement of cash flows, which is broken up into three parts: operating, investing and financing. It might be obvious, but it is ill-advised to invest or hold when a company has negative cash flow from operations and investing activities, but positive cash flow from financing activities. This means that the business is losing money, the business is spending more money as it tries to grow, and it is getting its money from loans and selling stock to investors.
On a more positive note, think about what the business is giving back to you as an owner. Does the company pay dividends? Does the company buy back shares? These frequently overlooked investment basics are two great ways to reward owners, as dividends are actual cash payments to the owners, and share buybacks help make your block of shares a bigger percentage of the pie (in contrast to making your share worthless by continually handing out more pieces of the company). Remember, there is only so much to go around.
Thinking about expensive stock
Berkshire Hathaway, Warren Buffet’s company, is worth about $110,000 per share -- a price tag that may scare you away from investing. A common misconception is that to find success in investing, you have to find stocks that are cheap (from a few dollars to a few cents). Sure, if you only have $1,000, you can not buy a share of Berkshire. You could, however, buy 100,000 shares of a stock trading at $0.01, but what are you really buying with that $1,000? How much of the pie are you getting with that stash?Consider the company's number of shares outstanding -- the total number of pieces the company is broken up into, minus the treasury stock -- and figure out the percentage of the pie you own. Furthermore, it is important to understand how that price per share, no matter how high or low, relates to the key indicators of a company’s health, such as money in the bank, cash flow, earnings, and book value.
Take book value, also called shareholders’ equity, of a company, which is the difference between assets and liabilities. On the stock market, companies often trade above their book value, which is an indicator of the base worth of a company in the event of a bankruptcy. Without simplifying too much, if you really wanted a TV that was worth $1,000, would you rather pay $2,500 or $10,000, which are 2.5 and 10 times the book value, respectively? The answer should be obvious.
Of course, companies that are more exciting or growing faster, tend to have higher multiples because people are willing to pay more for something that is newer and more exciting. Keep in mind that some companies have negative book value, which means it has more debt than assets. Price-Earnings ratio (P/E) is also a common indicator. Basically, a P/E of 30 means that you are paying $30 for every $1 the company earns, and it would take 30 years to get your money back. Imagine P/E’s of 100 or 10, and think about where the best place may be to put your dollar.
The above illustrates an often-overlooked investing basic: The actual price of a stock is far less important than things like what the company makes on a per-share basis. So, when you see a stock that has a high price tag, it may be a better deal than a company trading for pennies.
Know your place
The stock market is often referred to as a living, breathing organism. There is some truth to that as it is reflective of the buying and selling habits of millions of investors, mutual funds, pension funds, money managers, and traders. The market is there to help find a balance between buyers and sellers, and that balance ensures that stocks are priced right where they need to be at a certain point in time.
Initially, it seems that opportunity abounds because stocks can easily be overvalued or undervalued. But, before thinking that every stock is underpriced or overpriced, remember the sheer volume of activities that position the stock where it is. You may be smarter than a handful of investors on an individual basis, but it would be tough to outsmart the entire group.
Larger stocks, such as Wal-Mart and Coca-Cola, are followed by many people and analysts. This results in the availability of more information to more people, which helps them make informed decisions and helps find a balance in the stock market. In smaller companies, there may be less coverage or public knowledge, but you may be in the hornet’s nest with other investors that have a far superior knowledge than you when it comes to the particular stock or the industry it is in. New investors get into trouble when they feel they are smarter than everyone else. Even professional money managers have problems with this; over the course of several years, only about 5% of all mutual funds and money managers do better than the stock market in general.
As an investor, you can save a lot of red ink if you recognize your place and realize that there is a world of knowledge out there that is already priced into the stock market.
Do your homework
The simplest way to get into the stock market is to buy an index fund, which is basically buying the entire financial market. So, if the stock market goes up, your fund will go up. However, people are lured by great wealth and often believe that they can do better than the masses and outperform the market. It’s not easy and there are no guarantees you can ever do it, but there are some things you can do to position yourself.For starters, do your homework. To know more than the next guy, you’ll have to learn about the industry and study the trends so that you can formulate an idea on where the industry is going. Learn about the company’s competitors and its dependencies, such as oil if the company needs it to make the product. You’ll also want to consider the price fluctuations of resources such as oil.
Investors often stand the best chance to garner information and become an expert as a function of their jobs. For example, if you’re in the construction purchasing department, you likely have an idea of what companies are out there and the demand cycle for their products better than a psychiatrist would. Your profession is a great place to acquire specific knowledge (not insider information) that is not readily available to someone who is not in your field. Leverage that knowledge and you might put yourself in a position to succeed.
crash the stock market party
Even if you cannot outperform the stock market and are a lowly clerk for a company that makes washing machines, live the dream: Be an owner, buy stock in companies that do what you understand and know, start a portfolio, and enjoy the learning process. Even if you don't make millions overnight, brush up on these overlooked investing basics and take advantage of the opportunity to have fun while you expand your knowledge of an industry or company.Resources:
www.businessweek.com
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