The stock market is quite accessible, making it very tempting for many people to want to invest in it. After all, we’ve all heard stories of people making it big by simply investing in stocks. These days there are plenty of stories of people in their early twenties becoming millionaires by investing in the stock market. This raises a desire in all of us to do the same.
After all, if they can do it, then so can we. Right? Unfortunately, it’s not that simple. On the opposite end of the spectrum, we have people who firmly believe that investing in the stock market depends on luck.
However, that is not the case. In order to benefit from the resources available, you can depend on factors much more reliable than luck. Success in the stock market depends more on knowledge and experience than sheer luck. Knowledge can significantly impact your experience when investing in stocks. So, exactly what do you do?
That’s a good question and one that many beginners often overlook. This is what we call as a rookie mistake. Any experienced investor will tell you that downplaying the role of experience is actually what causes many people to lose their money. It’s too easy to blame luck when it comes to trading stocks. But you don’t need to do that because we’re going to tell you all about buying stocks.
As we said, the biggest disadvantage that new investors have is the lack of experience. For many people, trading stocks can be all based on the knowledge that other people possess. That’s the first rule of investing: you don’t have to listen to what others say. Just because someone wants you to buy stocks from a particular company because it’s ‘booming’, doesn’t mean that you have to do it.
You have to look at the companies you’re investing in by yourself. Different people look at things differently, and you will succeed only when you do it yourself. With that being said, let’s move on to the main purpose of this article.
In this article, we’re going to explore the factors which you should note before buying stocks of certain companies. We’re going to give you tips and pointers which you should look at before making your decision. So, let’s begin!
Looking at Companies and their Products and Services
As we said, you have to look at the company you plan on buying stocks of in detail. It may be wise to look into the overall profile of the company. You may want to ask around about the company’s reputation in the market. For beginners, we recommend that you buy stocks after understanding your circle of competence. The concept of the circle of competence has been used widely as a way for investors to focus on areas they knew best. In simple terms, a basic understanding of the operations and economics of a particular company helps an investor to evaluate the performance of its stock in the market. In such a case, there is no need for one to be an expert on every company. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital. Therefore, we urge our readers to buy stocks from companies in their own circle of competence.
Pictorial representation below will help you to understand the concept better:
Inner dark circle: Circle of Competence
When an investor is targeting a group of companies within his circle of competence, not only it is easier to keep track of the company’s progress in the market, but it also lowers the risk of losing money. After all, no matter how inexperienced you are with the stock market, you most definitely will know more about the market around your set of companies. This just makes the decision of investing easier.
Think of it this way. We know that the consumer durable and IT sector in India has been growing significantly in the last few years. In fact, these are one of the fastest growing sectors in the country. This is followed closely by the banking and FMCG industry. The auto sector is also on the rise in India. These are a few favorable industries to think about investing in. (Refer graph below from Wealth Insight May 2019 edition)
Compared to these sectors, telecom and realty industries aren’t growing that much in fact. Even the traditional manufacturing industries in India are quite stagnant when it comes to growth potential. We have an oligopoly in these industries which makes it difficult for new companies to make it into the market. This isn’t a bad thing; it has actually helped the government to regulate standards.(Refer graph below from Wealth Insight May 2019 edition)
Considering both, companies touching highs and lows of the market, an investor has to see and analyze the potential of growth in the company per se. As there can be various short term or specific factors for the growth or decline of the stock of a particular company. Therefore as an investor, one has to see the long term prospect of growth and potential capability of companies business in the time to come to analyze the investing opportunity. Further, the most important thing, thinking long term is the key.
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Also from an investor’s perspective, underperforming industries will have to be analyzed from their ability to optimize their sales by reaching a high user base of India.
Are the products or services selling? Is there a decline in the demand for them? These are the kinds of questions you need to be asking before you make the decision to invest in a company. It doesn’t matter how big or small the investment is. As an investor, your focus should be on making money and these questions put you on the right track.
You need to do the research yourself. Don’t follow anyone else’s advice. Most importantly, don’t make decisions based on ‘gut feelings’. While you may get profits once or twice by choosing companies on a whim, this isn’t always the case.
If you want to get the most profit from the stock exchange, then you have to make educated decisions. One of these decisions that you will have to make is how quickly you want your money back. Some people buy stocks of start-ups as their market shares are increasing rapidly because they think this is how they can make a lot of money quickly.
But which companies and startups do you choose? More importantly, how do you decide which company’s stock to buy? If these questions came into your mind, then you’re on the right track because this is where we’re headed to. Up next, we’re going to tell you how to decide which company’s stock to buy.
The profitability of the Company
One of the first things you should look at when thinking of buying stocks of any company is its profitability. This means that you need to look at how much potential each company has to turn in a profit on a quarterly or yearly basis. Depending on how quickly you plan to sell stocks, the profitability of the company can be very high or stable.
Some investors prefer investing in companies which may not necessarily have a very high-profit margin, but which makes an overall net profit on a yearly basis. These kinds of companies are very good for long term investment as they will give you a profit whenever you decide to sell stocks. These companies will not give you a lot of profit immediately but, in the long run, they are worth investing in.
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However, the kind of companies you decide to invest in will again depend on how quickly you want to get a profit from them. If this is the case, then it is advisable that you research the company’s market potential.
As a beginner, you probably don’t have enough experience to tell exactly when to buy and sell stocks to get maximum profits. If this is the case then you should definitely look at the market trajectory. Sometimes, some companies make a lot of money during the first few quarters but then as time goes on, their profits begin to fall.
If you miss the peak season to buy or sell stocks then you will find yourself facing a loss. So, in order to prevent this, you will want to keep an eye on the market. The stock exchange in India is subject to changes depending on the political climate as well. New policies can greatly influence stock prices.
The idea behind smart investing is getting familiar with studying the fundamentals of the company and maintaining a strategy around it. Adopt a long term perspective as long term investing is essential to greater success. Also, it’s important to invest based on future potential. As an investor, one might consider the stock market attractive when it tends to rise just before the new yearly budget or during election cycles. However, all these are temporary deals in the market and may not turn up into a very smart investing decision. Therefore, the basic ideology of evaluating a company’s past performance, say for last 10 years, reading annual reports and following the company with its ups and downs, major decisions taken in the past, diversification, its area of operations, expansion plans, etc, is the key to smart investing. Short term investing is not smart investing.
’Lastly, it’s very important that you look at the potential risks involved with the companies you’re investing in. Sometimes, smaller companies which have been doing consistently well in the market, suddenly face a loss or go bankrupt. This is because they’re not equipped to deal with their competitors. Therefore, you also need to look at the company’s initiatives as well.
You should also compare the profitability of multiple companies within an industry. Below you will find a chart of the various companies in the paint industry. As you can see, looking at their business model and their profitability makes it quite clear which company you should choose to invest in.
Future Initiatives of the Company
This brings us to the second section of our article which focuses on the initiatives of the company. It is very important to know about the managerial intent of the company you are investing in. This is actually quite easy to determine.
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All you need to do is, look the intent of the company and the amount of effort it is making to identify new geographic regions for expansions, investment in the new product lines, expansions by acquisitions, entering into different product line or market. All this shows a keen interest of the company to grow and provides for a growth in the returns to the investors, exponentially, needless to say, if all goes well.
These are red flags that management does not care to grow the company. They may be happy with where it is right now, and this reveals that very soon, the company will be stagnant in terms of making a profit- something which is not good news to investors.
This will cause stock prices to fall over time and you may find yourself getting the short end of the stick. It’s not just the telecom industry you should be wary of either. Any company in any industry shouldn’t spend too much time without new releases because this increases the risk of losing their customers.
India is one of the fastest growing economies in the world. And there’s a lot of investment coming into the country from all fronts. Investors everywhere have realized that there’s untapped potential in the country, so naturally, companies are pushing out products as soon as they can to attract investors.
If a company isn’t doing this because it’s happy where it is right now, it’s actually setting itself up for losses in the long term. It’s shouldn’t be about how the management is ‘happy’ about their company’s share of the market. That is not how business is done.
A company with a serious intent to stay in the market will do everything it can to keep its current audience as well as to attract more customers. So, no matter what anyone says about such a company, it is a bad idea to invest in it.
How much money Should You Put in Stocks?
Now that you have an idea of the kind of companies you should be investing in, let’s move on to the more technical side of it. While there is no set rule as to how much you should be putting into stocks, as a beginner, you should not expose yourself too much to stocks. This is done primarily to help preserve capital.
Since this article is aimed at those who are just starting to buy stocks, it is important that you will be financing your investment yourself. So what will you do? As a standard recommendation, at least 25% of earnings should be invested in the stock market. Regarding the mix of the investment, a commonly cited rule of thumb says that individuals should hold a percentage of stocks equal to 100 minus their age. So, for a typical 30-year-old, 70% of the portfolio should be equities. The rest would comprise of high-grade bonds, government debt, and other relatively safe assets. Further, as you gain more experience and find yourself studying and understanding the rise and fall of stocks more accurately, you can adjust this amount. Also, as the knowledge and experience grow, one may find fundamentally sound companies to invest in.
The Difference between Index Funds and Individual Stocks
A lot of people find it hard to distinguish between these two concepts. In this section, we’re simplifying these two terms for you so that you clearly understand the difference between them. An Index Fund enables you to put resources into numerous stocks by acquiring all the stocks in the same proportion as in a particular index. This means that it essentially gives you access to all the stocks in that particular index. For example, a particular Sensex index fund scheme will invest in all the 30 companies of Sensex and will perform in tandem and deliver returns. Here, as you see the below graph, the index should deliver returns according to the growth of Sensex.
Individual Stocks, on the other hand, do not generally have the ability to decrease the risk your portfolio is carrying. However, if your investment is spread across several stocks and in case of one stock crash, the effect on your general portfolio is not life altering. Hence, maintaining the right portfolio allocation is important. Also, if we talk about diversifying your circle of competence, an investor can expand it by studying and understanding various other industries and companies and expand its circle of competence over a period of time.
As Warren Buffet said, “Never invest in a business you cannot understand”.
Choosing between these two types (Index fund or individual stocks) can help you make a lot of profit and cut down risk. You should try using both, and depending on what works for you. Also, many investors get lucrative towards individual stocks but it requires a great deal to identify the right set of stock on which you can bet. However, an Index fund can give you a good return if SIP mode is followed.
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Numerous companies distribute their profits to investors as dividends, while others may prefer to use their profits to reinvest. Financing the purchase of future stocks with the profits made is a good idea as it can help you reduce risk.
Before you purchase a stock, it can be useful to know how volatile you can anticipate it to be. This is why we recommended you to look into the company’s history before investing. This helps you to understand how volatile the stock is.
Another thing which you should notice while doing your research is past trends. There are some patterns that emerge when you look at the rise and fall of the company. However, stocks with a background marked by profits give no assurance that they will always make profits. Here the knowledge and the understanding of the investor about the company and the market around it play an important role. A complete analysis is suggested to the investors that include the study of at least 5 years annual report, con calls, presentations, etc needs to be done for better understanding of the company.
This is because stocks with a solid history of profitability may fall for a time being. This is particularly true for big companies. In 2018, HDFC Bank’s stock went down by 15%. Now, any inexperienced investor might have panicked when seeing the trajectory and indeed, many people did sell their stocks. However, this was all in vain, because, by the next quarter, stocks were up by 12%.
This is what we said about timing. You need to do thorough research to make sure that you’re acquitted with the company’s history and profitability well. If you don’t know much about a company and buy or sell stocks based on patterns you see in real time alone, you may find yourself suffering losses. You have to look at both past and future trends to determine when to buy and sell stocks.
Both professional and novice investors have their preferred method for the measurement of profit margins and value, which they develop by looking at dividends and overall net revenue. However, it is important to note that even with all of these tips, there is no singular way of distinguishing good stocks from bad ones.
There is no denying that people do try to influence the market so you will find a lot of people hyping a particular company because it sounds good. Even in stocks, the saying ‘too good to be true’ exists. If something looks too good, then it is very important that you look further into it. As we have said multiple times through the course of this article, you shouldn’t follow what anyone says.
It doesn’t matter how good they are at trading. Since you are the one investing, you should take a look at companies you plan on buying from yourself. However, at the same time, a stock that looks profitable with double-digit profit margins can easily fall down to losses instantly, and a new tech startup that looks like a risky venture can give you twice the profit.
Also Read: Secret of Value Investing
The cost of a single share isn’t the correct number to assess when choosing if a stock is a decent purchase or not. While triple-digit prices may be unreasonably expensive for one investor with restricted assets, stacking up on penny stocks isn’t really a brilliant idea either.
As you can see, investing in stocks can be a very tricky process. However, if you keep these points in mind as you begin your research, you should be good to go. We would once again like to remind you that luck doesn’t play a big role when it comes to buying stocks. What you need to do is your research in the company you plan on investing in.
You need to make sure that the industry you’re planning on investing in has an overall positive growth potential so that you don’t face any losses in the future. As we have already mentioned, one way of doing this is by making sure that there are no market forces acting against the company you’re investing in. These are a number of factors which we have discussed in this article in detail.
Local and national elections, as well as a crisis in the country, can greatly affect the stock market. Government policies also have the power to influence stock prices so it is very important that you look into legislation and policies before making an investment. Remember, Knowledge with the right set of research and information around company’s current performance and its future potential is the key to making profits because if you are buying the stock at the right price then you can create good value in the stock market. As Warren Buffet said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”
Lastly, we’d like to end by reminding you once more that you should not let anyone influence your decision to invest in particular companies. Sometimes, certain individuals overhype some companies to influence people to invest in them. Be cautious of such schemes and use your own mind when making an investment. You’ll do fine when you do your own research!