Learning to Invest- Choosing your first stocks
The original idea for this post started with a rant I wrote about women not investing enough. I am now continuing in my series of Learning to Invest.
Incase you missed the first 2 parts, here they are:
Learning to invest involves a lot more than someone simply telling you which shares are most likely to end in good and bad investments. After you move past using a mock portfolio, you will quickly find that while it seems pretty straight forward in theory, actually learning how to predict the direction the market will predominantly move in is considerably more difficult than it sounds.
Before you continue any further, here is a brief list of some very important terms you should become familiar with:
- Buy, Sell and Hold: These are exactly what they sound like – you will start off buying shares or mutual funds, monitoring them over a period of time, and then deciding whether you would like to sell or hold onto them. During the course of your investing career, you will slowly start to learn how to identify when it’s the appropriate time to execute each action. The only way you can learn how to do this is through trial and error; no one can accurately make these predictions for you.
- Balance Sheet: This is an important part of your market research, and it’s where you will learn more about the company as a whole. For instance, in a company’s balance sheet, you will find how much debt they owe, their behavior of their inventory, and of course their cash flow, as well.
- Earnings Growth: The earnings growth is also a pretty straightforward term – it’s simply a measurement of net income. Oftentimes, investors will look at the earnings growth over a period of several years to predict the future numbers.
- Mutual funds: In the simplest terms, a mutual fund is a collection of assets in which you, as the investor, have the ability to withdraw from at any time. As a beginner to investing, you will most likely do better putting your money into mutual funds than you will single stocks. While there is still fluctuation in a group of shares, they are less likely to experience the extreme up-and-downs that single stocks can.
- Single stock: Again, this is exactly what it sounds like – an individual stock that you are investing in – which is often very difficult in terms of predicting its behavior. In general, it’s usually advisable to avoid single stocks when you’re first learning to invest with a real portfolio. However, it is a good idea to keep practicing with them in your mock portfolio so that you get the hang of predicting their behavior over the course of 52 weeks.
- Price-to-Earnings Ratio (P/E): To determine the P/E of an entire company, or even a single share, you will need to first find out what it’s earned over a 12 month period after taxes. Once you have this number, you will then need to divide the market capitalization by the after-tax figure that you determined. This is an equation that you will need to learn how to use in order to determine the overall expense of a stock or investment. As a general rule of thumb, try to avoid stocks that have a high P/E when you’re first entering the stock market; the higher the ratio is, the more likely you are to lose money on it. Of course, this isn’t always true, and some people experience an enviable rate of success with so-called “risky” investments. However, until you are comfortable predicting market behavior, this is a poor choice for your first investment.
Important Tips about Choosing Your First Stocks
- Don’t base your decisions on the price. Similar to many other aspects of life, a cheap price doesn’t always translate into a sound decision. On the other hand, an expensive price tag isn’t the best way to determine value, either. The only way you can determine whether or not you should invest your money into a share is by crunching the numbers yourself, and taking the time to dig deeper in the history of the company.
- Take the time to do your own market research. Although you shouldn’t be afraid to ask for advice, don’t forget that relying solely on other people’s recommendations will only lead to failure. No one can accurately predict the stock market; you can only try to make sound judgments based on past behavior.
- Remember to check the highs and lows. Speaking of making decisions based on past trends, make sure you always take the time to analyze the full picture. For individual stocks, you should at least go back one full year because they fluctuate a lot.
On a final note, when you’re learning to invest, it’s important to fully assess your risk. You should never go into an investment assuming that you’re going to walk out with fuller pockets – even though you will be purposely weeding out the bad investments for the ones that have a higher potential for being profitable. Instead, choose the amount of investment capitol that you start with by examining how much money you are prepared to lose.
When I have more money (ie, when I get a real job), I can’t wait to invest. All of my savings hang out in my EF so that I can pay tuition right now, though.
I loved and hated student because of this. Can you put aside anything to invest?
I have a real job and no money to invest yet. I am hoping this blog pays off. lol I have a ways to go. My wife just got a job so we should be on our way up now. We were a one income household with 2 kids and it was kind of tight…
I can imagine. Hopefully the blog pays off enough to start some money aside to invest.
I suck at stocks. My step father is great at it but I just can’t divide the day anymore. I need another me. Maybe I should photoshop me to help out.
Haha, Jai.
Haha did you see that video on Furiouspete.com the before and after of the chubby guy and the muscular toned pictures. Lol the photoshop comment made me think of that.
These are some great metrics and ideas to start with. I also really like looking at the PEG Ratio as well which takes into account growth against the P/E Ratio. Typically, a company with a faster growth rate than their P/E Ratio is a good buy all other things considered.
I need this series so much. I have a question about the P/E ratio. Where do you get the market capitalization figure? Did I miss that in an earlier installment?
You didn’t.
Market capitalization (also known as market value) is simply share price times the number of shares outstanding. So basically how much it would cost for a company to buy out all shares at the current stock price.
There are different types:
-Small market capitalized stocks or small caps range in value from 300 million to 2 billion dollars.
-Middle market capitalization stocks or mid caps range in value from 2 billion to 10 billion dollars.
-Large market capitalization stocks or large caps are stocks with a market capitalization of over ten billion dollars.
-Mega market capitalization stocks or mega caps are stocks with a market capitalization of over 200 billion dollars.
Does that help?
Great metrics. I find that as a newer investor index funds are a great way to start getting the hang of things. They are relatively low risk.
Thats what I started with. I can’t say enough good things about e-series funds.
I learned to pick stocks when I was 10 or 12. But now I follow a golden rule. Unless you have an hour a week to research your stock don’t trade. The best strategy i am following now is buy and hold for long term
I do that with most of mine, but things like Linkedin etc, which are flashes in the pan, need to be sold right away otherwise you are stuck with a dud.
When I first started to invest in individual stocks I made many mistakes. The worst one is not fully understanding what I was investing in because I didn’t do enough research. The idea of a mock portfolio is good because you commit to your positions without actually risking any money.
I would like to suggest to new stock investors. Take a look at exchange traded funds along with individual stocks. The reason that I like exchange traded funds so very much is because they can reduce your risk because when buying a exchange traded fund your buying a whole basket of stocks instead of just a single security. In theory an exchange traded fund can not go to zero unlike individual stocks. The second advantage of exchange traded funds is that their are now thousands of funds to choose from. I particularly like narrowly focused funds that specialize in coal steel solar stocks among others and single country funds which buy securities in a single country like china india among many others. Because of the wide array of funds available Today you can build a diversified portfolio of funds’ Concentrating on the exchange traded funds that are most out of favor and have declined by the largest percentage. For example their is a solar Exchange traded fund that trades around 3.00 dollar a share it was trading at 30.00 dollars a share about five years ago. Their are also some single country exchange traded funds that are down by 80% from their highs. The only word of caution for anyone considering investing in exchange traded funds is this always avoid exchange traded funds that use leverage to magnify their returns. These exchange traded funds usually are marketed under double or triple the return of standard and poors five hundred index or some other index. So be very careful of these exchange traded funds because their a very dangerous place to be putting your money their more like options or futures than exchange traded funds in my opinion.