How I Pick My Stocks: Investing Tips For Beginners
So, I’ve got a secret, and it’s about time we talked about it. This is my crystal ball and it allows me to protect everything the stock market’s going to do in the future.
Look, if anyone tells you that, never believe them. They’re probably just trying to sell you one of those courses for $997.
So, even though there’s no magic ball that can tell you when to buy a stock before it rockets in value and makes you a millionaire overnight, there is certainly a few things I do to tip the odds in my favor, and that’s what I’d like to share with you guys today.
As I’ve got older and slightly grayer, I found that knowing the reason behind why a stock might change in price help me make and save a lot of money.
If you’re new to the stock market, then a stock is a small part of a company, and when you buy it, you actually become a part owner. The idea is to buy parts of a company that you believe will go up in value so you’re able to multiply your money without doing any extra work.
But let’s face it, investing in the stock market can be pretty confusing, and most people just pick companies on a whim, however, that’s not how I do it.
You’ll know my actual strategies for picking great stocks. And don’t worry. I won’t be trying to sell you anything, so you can just sit back and relax.
So, there are two main ways to attempt to predict the stock market. These are called technical and fundamental analysis. A good way to think about this is like a scale.
Usually, short-term day traders are purely focused on technical aspects. These include looking at charts and patterns. They believe that they can predict how the stock will change in price by judging the highs and the lows on the graphs.
They’re the geeky ones. Nah, I’m only kidding. It’s just not how I do it. My whole investment strategy is about keeping it simple. Lots of people talk about using margin and options, but that’s really not something I worry about.
I’m a long-term investor, so this means I’m a lot more focused on the fundamentals of a company. This includes the financials, the leadership, and the brand recognition, as I believe this is where the information lies to indicate the long-term success of a stock.
However, like I mentioned, it’s a scale, so I do pass my eye over the occasional chart in order to find the best time to buy.
This approach has helped me to find some really good investments over the years, rather than just dipping in and out and trying to make a profit on a daily basis.
The amazing thing is the majority of professional traders are still unable to be a low-cost index fund over the long term. This may sound quite complicated but it’s actually very simple.
So, Imagine a bucket filled with water which represents an individual stock, and the water is me pumping all of my money into that company.
Now, imagine a cup filled with water which represents an index fund, each cup being a different company, and the water I’m putting in is the money I’m spreading between each of them in one easy investment.
For whatever reason, if this company goes bankrupt, then guess what? All my money goes down the drain.
Now, this is the same company and it still goes bankrupt, but the good thing is I might lose my money in that small investment, however, I’ve got so many more stocks and I’ve done really well in some of them, which means I’ve actually made a profit overall.
My favorite index funds track the S&P 500 which are the top 500 public companies in the USA. So, even though the majority of my money goes into index fund investing, I also have a lot of fun picking individual stocks and watching my portfolio grow.
Right, so now you’re ready to invest, but where should you start? Well, if you’re anything like me, it makes sense to start with the numbers.
We call this quantitative analysis. Whenever I’m thinking about investing in a company I make sure to look at all these figures first. If the financials don’t look good to me, then it’s very rare that I’ll do any further research into the company.
It’s kind of like when you go on a first date with someone and they seem really nice, however, it isn’t until you really start getting to know all the details about them that you might start to notice their flaws, like eating with their mouth open or picking their nose.
If only they gave you a non-biased comprehensive list of how they actually are so you can make an educated decision whether you want to date them or not.
I don’t have a solution to this problem, but luckily that’s exactly what companies do. It’s brilliant. You can find out this information for free on Yahoo! Finance, which is the website that I use.
There are three main aspects that I look at. First, let’s break down the balance sheet. I know it doesn’t sound too interesting, but trust me, this is where you find some of the real juicy information.
The whole purpose of this sheet is in the name: to balance assets and liabilities. Think of it a bit like this.
You may own a watch or rental property, and these are your assets, but let’s say you have loads of credit card debt. This is one of your liabilities, so let’s break down some of the investing terms so you can easily understand this complicated-looking sheet and impress your friends.
Assets are broken down into three categories. Current assets are things that could be turned into cash within 12 months. Longer-term assets are things like their headquarters which they usually don’t sell in a hurry.
Companies can also have assets that you can’t physically touch known as non-tangible assets, such as the brand recognition of an established business that has been trusted for generations.
I like to think of Coca-Cola. And then we come to the liabilities, and what I’m really interested in here are the current liabilities as this is the debt that they’ll need to repay within 12 months.
With this, there is a simple calculation you can do to easily know if the company is high-risk or not, and that is total current assets divided by total current liabilities.
A good rule of thumb here is the numbers should be above one, but how does this work in practice?
Let’s take Apple’s balance sheet, for example. Apple’s total current assets divided by their total current liability comes to 1.4 when rounded up.
This is great as now we know that Apple are able to pay off all their short-term debt nearly 1–1/2 times. The second document is really important to have a look at is the income statement.
If you’ve ever heard the saying of the top and bottom line, this is where it comes from.
At the top of the statement, this is the total revenue, which is the total the business take, and at the bottom is the net income, which is the money that the company makes after all the expenses have been deducted.
Every business has these expenses, the cost of operation and the cost of revenue. So, let’s take a simple business like a smoothie company. Their cost of revenue is fruit.
They can’t make their smoothies without buying that. Therefore, that is a cost they have no choice about.
It’s a simple fact of running their business, but the next thing they do have a choice about, which is their operating expenses: who they’re hiring and what kind of wages that they’re paying them.
After these expenses are deducted from the total amount of money they take for their customers, you get the operating income.
So, here’s my simple calculation that lets me know if the business is healthy: operating income divided by total revenue times 100. Ideally, I look for above 15%.
Using Apple again, we get 27%, which is great. The last one of the big three is the statement of cashflow.
I’m not going to spend too much time on this one as when you boil it down, it’s pretty simple. The main thing I look out for is if the company I’m investing in has increased in free cashflow year on year, which is money they can use to reinvest all payback to investors.
A big red flag here is sometimes I see the cash flow is negative but the company’s still paying dividends back to its investors. It’s just unsustainable, and eventually the business is just going to run out of cash.
Now, once I’ve had a good look at all these numbers, it’s time to get into the juicy stuff, and that’s all about analyzing the qualities of a company.
This is known as qualitative analysis. One of the qualities I look for is brand recognition. When I say the word Apple, most people think about the company rather than the fruit.
I know I keep referring to it, but it’s a great example of amazing brand recognition that won’t be going away anytime soon.
Being a household brand name comes with a lot of consumer trust, so when they launch a new product, people are much more likely to try it out, especially if it’s something unique or groundbreaking, such as the iPad.
This helps companies like Apple shape our future and create entire new markets and revenue streams. Another great example of brand awareness is Coca-Cola.
It’s the second-most recognized word in the world after okay. Something that really affects price movements is the news. I always keep an eye on it, and in particular rumors on social media.
You may have heard about the whole GameStop situation where a small bunch of retail investors managed to outsmart the top hedge funds by finding a flaw in their strategy.
They were able to use this to their advantage and earn a lot of money. It’s Wall Street’s David versus Goliath. The struggling video game retailer GameStop skyrocketing about 8000% over six months.
But once the news broke and more people started to jump onto the bandwagon, the big profits had already been made.
This is a great example of the age-old saying, “buy the rumor, sell the news.” I learned this valuable lesson during the dot-com boom in the ‘90s.
When I started investing, people were amazed that I was pouring money into companies whose main asset was a .com domain name. However, within six months, it seemed that everyone’s telling me that they were buying shares in.com companies, even my hair dresser.
I decided to start selling to buy more real estate just weeks before the bubble burst, and I managed to save the majority of my profits.
Others weren’t so lucky. Everyone thought that internet businesses were the future, and they were eventually right, however, most of the original companies never recovered, and I saw some of my friends make millions just to lose 90% of their investment when everything crashed.
Only a handful of companies managed to weather the storm, such as Amazon. This showed me that the hype generated by the news and other people talking about it really just caused the prices to get out of control and become unsustainable.
So, whenever I feel like hype is driving the price of a particular stock, I know that it probably isn’t a great long-term investment.
Although, with the dot-com bubble, it is true that a lot of companies did rebound eventually. The next important factor is the leadership of the company, even more so nowadays with social media, and what the leaders say is having a huge effect on the price of the stock.
A prime example of this is Elon Musk, who is very clearly the visionary behind all of his companies, one of them, of course, being Tesla.
Just imagine if Elon Musk decided he was bored of making electric cars and tweeted that he were standing down from Tesla to focus on SpaceX and his mission to colonize Mars.
I think this reliance on Elon Musk is one of Tesla’s greatest strengths, but also one of its greatest weaknesses, as the company is highly affected by his actions.
This brings me to my next point, which is to look out for emerging future industries like electric vehicle technology, which Tesla is leading the way in.
These types of investments are really your growth stocks. My friend, often tells me he believes that in the future, doctors will be replaced by artificial intelligence.
This sounds like the stuff of science fiction, however, when I was younger, this was what I used to see on Star Trek.
In fact, this is even better. I actually first heard of Tesla when it was featured on “Top Gear” in 2008. It wasn’t a very flattering review as they showed the car running out of batteries in 50 miles, which was only a quarter of the advertised range.
Elon wasn’t very happy about this and he actually later filed a lawsuit against the show. However, the segment certainly piqued my interest and I could see they were onto something.
During my time investing, I’ve seen a huge shift in each sector. Let me take you back to when I was younger, if you can imagine that far back.
I remember sitting at my grandma’s house and watching this guy come along with a sack of coal on his back, which he would deliver to my grandma so she could heat her house.
Nowadays, most people use gas, so no more Mr. Coal Man, and this sector is all set to change again with the introduction of renewable electricity.
But that’s three major shifts that I’ll experience in my lifetime. If I’d been stuck in my ways and not taking notes to these changes, then my investments would have been left in the past, just like the coal industry.
So, before investing in a stock, I always think about whether a future shift in sector will have a positive or negative impact on that company.
But how do I predict when the best time to buy is? You don’t, but there’s a strategy I use to get around this, and it’s called dollar cost averaging.
Let’s imagine you were to invest once a month for three months. Month One, the stock might cost you $200, Month Two, $150, and Month Three, $130.
Of course, if you knew it was going to dip to $130, you’d have bought then, however no one knows how low the price will go. But by doing this, instead of investing all your money in Month One when your stock was at $200, you actually lower your average buying price to $160.
This is also known as buying the dip. Instead of getting scared and selling like the majority of people would, the idea is to buy more, because it’s like having a garage sale, and if you’ve done all your research and you like the company, then the stock is at a bargain price.
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