Finding a good quality investment is not as hard as you think, it just takes some research, basic analysis knowledge, and some courage. The more knowledge you gain, and more experience you have will make it easier to spot good investments.
I’m a big fan of dollar-cost averaging and value investing so these are the strategies I will be basing the examples in this article on. Also I think if you are just starting your investing career, these techniques are easier to use and offer the most protection. But you must be warned, to be a successful investor you have to play the long game.
Let’s just get this out the way… You might do everything right, your investment might look overwhelmingly fantastic, but the stock market has its mysterious ways. Even if it looks like nothing can go wrong, there is still a chance the stock will fail.
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Before you invest in the stock market
Before you invest your money I would recommend reading our other articles, especially our 8 tasks to complete before investing in the stock market.
You need to not only be physically ready to invest, you need to be mentally and emotionally prepared to have your money potentially tied up for years. It is no good investing $100 then a week later needing it for a night out. That sort of behaviour can lead to you losing money, or worse, missing out on profits.
What you can invest in
There is a general guide of difficulty when it comes to investing, if you’re a beginner you’ll be at one side of the scale, whereas a more experienced investor will be at the other. You don’t have to follow this guide, but I think if you’re unsure about valuing your investment, the less complicated options are normally the better option.
Funds and blue chip stocks are the more secure options when investing. They follow the general trend of the market and are not very volatile. The Vanguard Fund (VOO) is an example of a trusted ETF, and utility companies are usually considered a defensive blue chip stock.
If you are a cautious investor, I would look at the dividend aristocrats as a starting point for your research.
Growth stocks are very difficult to predict, these are stocks of new companies that are growing, they pose a higher risk, but can bring higher rewards. Whereas cyclical blue chip stocks are such companies as Apple, Amazon, or Microsoft, they are well established companies, but they are consumer driven. If the economy dips and people stop buying, these types of stocks will be affected, they tend to do better in bull markets.
Chose the best companies for you
Companies you are familiar with, or industries you work in will have general trends or triggers. You should look closer to home when thinking about an investment, if you work in aviation, you might foresee changes in the industry that will impact the companies within the niche. This way you can better time your investment plan to marry up with any big news or changes.
Some simple industries include:
- Waste Management
- Banking & Debt Management
The industries outlined here are generally easier to predict because they promote big changes within the companies, if Apple brings out a new iPhone, they have release dates, press conferences, and TV adverts so you know they are confident with the sales projection for the product.
The best way to understand what to look for in a company is to have a set list of rules which you follow, check out this stock picking checklist over on PainFreeInvesting.
Take waste management for example, the volatility of waste management companies is among the lowest on the market, because no matter what happens politically, even if it affects the entire market… People will always need their waste collected and disposed of. Check out the charts below:
You can see when corrections occur in the market, the waste company is more sustainable, because… People always need waste management! Also because the company isn’t consumer driven, and it doesn’t have to follow legislation guidelines as much, the company can steadily grow. Whereas with Pfizer, legislation changes, new medication needs, and consumer debt all affect the share price.
The main premise of this explanation is to find companies that can withstand harsh conditions, and provide balance to your portfolio.
Principles of valuing your investment
The number 1 thing you need to understand if you want to find a good investment is… Price and value are not the same thing! Once you understand the value of a stock, then you can buy at the right price.
As I mentioned before, I am a value investor, Warren Buffet and Benjamin Graham are possibly the two most successful investors ever, and they are also value investors. It is a long term strategy that is based on the Intrinsic Value of an asset rather than the market price.
- Intrinsic Value: The perceived value of a company or asset, including both tangible & intangible aspects of the business.
- Market Price: The price of the asset or ownership stake in a company at that time.
The market price might change in the short term, but the intrinsic value of the company does not.
There are 4 main things you want to consider when estimating the intrinsic value of a stock:
- Future cash flows: How much money will this business make in the future?
- Discount the value of cash in the future to present value
- Get a rough figure
- Focus on more stable businesses that give you more information and forecasts
There are many methods you can use when calculating the intrinsic value of a stock. If you want to see which one I use, which happens to be the same as Warren Buffett check out How Warren Buffett Values A Stock By Calculating Its Intrinsic Value.
The main thing you need to consider is… If the intrinsic value of a stock is higher than the market price, it is undervalued and you should consider buying. However if the stock is overvalued, meaning the market price is higher than the intrinsic value, you should hold off until the price is right.
Calculate intrinsic value, but don’t live and die by it. This is one metric, the cash flow of a business (which is what intrinsic value is based on) is nothing if the company does not plan on using it. We need companies to grow, and the only way to grow is by making more profit, or diving into new projects.
Fundamental basics of analysis
Fundamental analysis is something every investor needs to know how to do. The fundamental approach is based around analyzing a company’s performance. We will look at a variety of factors that influence a company’s growth potential. Some of which include, the industry as a whole, the company’s management structure, Income reports, and any competition.
Basically, fundamental analysis will help you determine a stocks ‘fair value’.
The various branches of fundamental analysis can be grouped into 2 categories:
- Qualitative: Based on the quality something, not size or quantity
- Quantitative: Can be measured and expressed in numbers
In the context of the stock market you might describe the 2 branches like this:
- The qualitative fundamentals are less tangible. They could include the quality of a company’s management team, it’s authority in the industry, or any patents and proprietary technology it owns.
- Whereas the quantitative fundamentals are measurable characteristics of the business. We can find information like this from the balance sheet, income statements, and cash flow models.
Both of these aspects of a business are important to your decision, depending on your personal opinion you might favour one or the other, but you should consider both when picking a stock.
If you want to know more about analysis techniques check out my next article: Which One Should You Use: Fundamental vs Technical Analysis!
Speculating vs Investing
Investing is taking a calculated risk attempting to make a profit. The level of risk taken on during a transaction is the main difference between investing and speculating.
If you spend money with the expectation of making a profit, you are investing. You have done the necessary research to make a decision and have reasonable judgement through investigating the soundness of the investment.
Another person spends money in the hope of making a profit. With no prior research, and analysis, they are gambling with their money. The success or failure of their venture depends on chance, or uncontrollable events.
Learn in more detail what the differences are between speculating and investing!
Plan for success
You must plan for success when doing anything, especially investing in the stock market. You should learn as much as you can about investing, you should do these 8 things before starting your journey, and you should set yourself a goal for 5 years down the line.
To get you started, here are 10 tips to succeed when investing in the stock market!