General principles of stock investing for beginners.
To start, I would like you to consider and follow the below quote:
“Invest only if you would be comfortable owning a stock even if you had no way of knowing its daily share price” - Benjamin Graham
Indeed, the peace of mind that proper research on the company and its stock provides is golden. This is likely the most important point for the beginning stock investors. The peace of mind makes it easier for the investor to go through down periods. In tough times of declining market, you will know that you did the due diligence and the company you invested in is a solid one. Even if you are terribly wrong 2 times out of 10, you are still in good shape. Lose money on 2, profit on 8. In case the whole market goes down, guess what, strong companies fall less and recover faster.
If you are a beginner stock trader, your first goal is to not lose money. Best if you succeed with your first stock pick and make some good money. Therefore, choosing well your first 10 stocks is very important. Success in choosing stocks stems from finding great businesses whose profits and shareholder returns will grow. This usually happens for three reasons:
The company's products are successful among consumers and over time it beats its competitors gaining a larger and larger share of the market (consumers’ wallets);
The company is growing rapidly (10-30% per year), and the competition in its market is not strong enough. Hence, the company can continue to charge premium prices on its products. With that it generates good profits that it either distributes to shareholders or reinvests in new business operations;
The situation in the world or market is changing (prices for raw materials or final products, the cost of crediting and debt burden is decreasing) which benefits one or several companies.
If you find a company that meets one or several of the above, then the company is likely to grow its revenue and profits year after year. With that, the value of its shares also grows.
STEP 1 – Building a simple stock portfolio for stock investing beginners
To get started, you can choose 4-6 stocks from different sectors. This will make sure your portfolio is diversified, but you also have time to keep track of it.
To choose the best stock to invest you can follow the below approach:
Read a lot about stocks, industry trends, analytical opinions. This will take you to the next few steps as you will start identifying industries and stocks that interest you. Don't rush into buying yet!
Identify the 4-6 industries that you think will grow.
Identify 12-18 companies/stocks in those industries.
Go to the websites of those companies in the section “Shareholders and Investors” and read presentations about the business. I prefer those Investor presentations to financial statements because investor presentations talk about financials and lay out the future plans and strategy for growth. It is also a good idea to listen to the recent presentations if there are any. Many companies use third-party solutions to record and store their presentations.
Check company valuation taking into consideration future predicted growth. This step is probably the most difficult, but you have to do it. Stockmarket investors sometimes get overexcited about a company or the whole industry and send the stock price to very high levels that are not warranted by future earnings. It would be a bad idea to buy the company's stock at the moment of hype as it may eventually fade and the stock price will decline. I am going to make a separate detailed article about valuations.
Buy the stocks that you like for growth and valuations
In a general sense, a company that usually grows in value satisfies 2-3 basic criteria:
it either grows rapidly or pays dividends steadily and at the same time invests in development;
you see clear reasons why its revenues (revenue, profit) will eventually grow by at least 20-30%, which will become the foundation for the growth of the value of your investments (growth forecasts are given by management if you read the presentations on the website or analytics);
the company is in a good financial position;
its product is in demand.
I would like to stress the importance of point 4 from the above list. Some people say that behind every great company there is a great manager/leader. Think Facebook, Apple (Steve Jobs days), Amazon, Tesla, Virgin group of companies. When reading through investor presentations and listening to managers speak pay attention to 3 points:
What they say (what are the plans for growth, how was the performance for this year, etc.)
How the say it. Is the presentation clear? Is the management clear in their vision? Are they the ones that can take the crowd and lead? Would you want to follow this person? Unfortunately, too many great ideas and companies were killed by management who do not know what they do or are just there to collect their next paycheck.
Lastly, pay attention to the questions and answers after the presentation. How does management handle questions? Are they in the know? I also pay attention to companies that ask questions. Keep in mind they are representatives of the big investment companies that are scrutinizing the company and its presentation. Based on the presentation they will be deciding whether they want to invest their millions of dollars into this company. If they do, this will definitely result in an increase in the share price.
STEP 2 - Set your Trading Plan: Formulate Investment Idea, Goal, Timeline, and Exit Criteria
Once you've decided on the company/shares you want to invest, it's important to set in stone (best if you write it down) your investment idea, your investment goal, investment timeline, and exit criteria. For example:
I expect a 20% revenue growth for Facebook in the coming 2 years due to the success and growth in the user base of its Instagram and WhatsApp social networks.
I will follow Facebook results from the quarterly reports of the company in the next 3, 6, and 9 months.
For each of the quarterly results, I will check the reported growth vs. my expectations. If the company performs according to my expectations or better, everything is going according to the plan and I should expect the stock price to increase.
If, at the end of 6 months, income does not start to grow or force majeure occurs. I will sell the shares and fix profit or loss.
It is very important to have a clear plan and stick to it. Otherwise, a once coherent idea will turn into hopes and expectation game. This usually leads to a big loss down the road. What's worse by holding a losing stock you have your money locked in it while you could have invested it in other opportunities.
STEP 3 - Monitor the performance of your investments
As soon as you buy shares, you can see that their value changes. This is absolutely normal, and even if on the very first day your investments drop by 2-3%, this is also a variant of the norm.
At this moment the key is not to panic. Do not forget that you are betting on significant changes for a long period (a year or two depending on your Investment Timeline). Patience is the main quality of an investor. The best idea is simply not to look at trading statements every day. Remember, you did all the due diligence, you know the company is good, is healthy, its management knows what it is doing, and its revenues (according to your research) are going to increase in 3, 6, 9 months.
During a week or month, there are rarely any significant changes in the valuation of companies, so all fluctuations are a result of the fact that the comparative attractiveness of your stock and market sentiment changes.
STEP 4 - Studying the market reactions
If you read the presentations about the company's business, you can easily guess what factors can positively or negatively impact the company's revenue and profits.
Let's go back to our example with Facebook:
• Facebook clearly benefits from the growing base of its users and users of its acquisitions (Instagram, WhatsApp, etc.), expansion into new apps, features, etc.;
• The company suffers from any problems with litigations, bad PR around collecting information about users, other companies deciding to massively stop advertising on Facebook's platform.
Accordingly, the value of your shares will change as the market changes its expectations for these business parameters (initially, market professionals have a fairly accurate picture and mathematical models of all parameters).
In addition, such factors as the expected dividend, the volume of investments in new projects (this is counterintuitive, but investors do not like new projects, because this is a risk for dividends) ... and of course the general mood on the market. This factor affects all stocks.
By studying price movements and trading volumes, you will gradually understand which news is the most important.
And if you also study analytics from investment companies, you will understand how exactly this or that news can affect the business performance of the company: how much (in percent or in dollars) will be the change in revenue or profit.
Eventually, everything will start to fall into a clear picture - it will become clear why some news does not cause any movement (or cause one-day movement with the price returning back to normal the next day), in response to others, the stock drops or rises sharply. Based on your experience you will know if this or that news is substantial and you need to sell your shares or if it is just noise and share prices will not be impacted in the long run.
STEP 5 - Do not forget to take profits (or losses). Rotate your portfolio.
As events unfold, it is important to make exits (close your positions):
there will be investment ideas that did not work as you expected, and they need to be written off;
there are ideas that “shot” and you need to take profit and move on to the next investment idea.
Remember that every investment you make is NOT an investment in something else, and if you compare trading stocks to playing on a racetrack, your bets should be on the best horses. If one of them has just broken a leg, you cannot allow yourself to sit and wait for a miracle: your time is costing you missed opportunities in other good investments (in other words, you trade a good chance for a dubious one).
By repeating this cycle (analysis - selection - formulating a trading plan - monitoring - fixing profits or losses and rotation), you can earn and gradually improve your trading skill in the following areas:
screening for investment ideas;
choosing investment ideas;
finding the best entry and exit points;
correct assessment of intermediate results in order to carry out the release or rotation of ideas on time.
Profits will definitely follow.