Investing in stocks is a very important skill for any gent looking to make his money work harder, but it does come with a sense of mystery and danger. Career stockbroker Joe Batchelor gives his take on how to start a stock portfolio and what to avoid as you build wealth.
Investing in stocks. It sounds like a very grown-up thing to do, and something many of us has intended on exploring, eventually. Investing gives you an opportunity to grow your money and have an alternative income with limited input. It’s also prudent during a climate when banks may actually start charging you negative interest rates to park your money.
Choices, Choices
The first step before you start investing is to evaluate your options, which include listed equity (stock market companies); private equity (unlisted companies); credit or debt (where one participates/lends to a company in the form of a bond and received interest/rent/yield payments in return); real estate (as an owner and/or landlord); and ‘alternatives’ (new sectors such as cryptocurrency, e-sports, cannabis or hedge funds).
These opportunities all come with different levels of risk, reward, liquidity – the ability to get money in and out – and duration or the length of time of the investment. For instance, property exposure is usually a mixture of a cash down payment (equity) and mortgage lending from the bank (credit) over a longer period. In contrast, stocks can be sold very quickly and liquidated into cash just as fast, which is why it’s one of the most liquid forms of wealth.
Time to Take Stock
A stock in its most basic form is an equity investment that represents part ownership in a corporation and entitles you to part of that corporation’s earnings and assets. Share ownership is usually recorded electronically, and the shares are held in street name by your brokerage account. You can invest in shares through your bank accounts with the likes of HSBC and Citibank or through independent providers like Fidelity, Interactive Brokers and Vanguard. The key here is that all providers come with different fees and different tools to help you make decisions, but ultimately, they offer the same services.
While mastering the stock market is as complicated as it sounds, making prudent investments is something anyone can do with a little education. Stocks are an opportunity to play well-governed, integral, liquid companies that you like and enjoy following. The best way to invest your money in stocks is to buy into great companies and hold them for the long term. The best investments don’t need you to check in on them daily because they are solid companies with competitive advantages and strong leadership. Patience is the secret to investing in stocks and making money grow.
Make Your Money Work for You
Stocks are an amazing way to make money and offer the highest potential returns. The major chunk (normally a 50% weighting) of most investor’s portfolios is stock exposure across a number of individual company holdings or ETF (Electronically Traded Funds), funds traded on stock exchanges much like stocks. These avenues offer a super powerful way of riding themes and exposure to different sectors. However, they also come with their inherent dangers – emotion, greed and not sticking to basic rules – but these can easily be avoided.
Perhaps you like fast cars, nice cocktails and debate with friends about social media. These are all themes that can be explored further, and you can find ways to invest in these sectors. Auto companies, for instance, offer a huge selection in size and geographical exposure, from large companies like Toyota and Nissan to niche names like Ferrari. They offer new growth opportunities given the growth of self-driving and hybrids.
You may even like to explore newer names like Tesla that offer higher growth and pure exposure to a new theme. Alternatively, look into companies providing the lithium batteries to the hybrid automakers. To round out this thematic investment further you could find an ETF that perhaps gains when the price of oil goes down.
When Vices Pay Off
Perhaps you’re more interested in vice as a theme. Diageo has been a major player in the global alcohol industry for years and has been buying up smaller brands and expanding its global footprint; the stock has gone up 100% multiple times. Large companies with lots of cash flow also may offer a dividend (a sum of money typically paid annually to its shareholders out of its profits), which is an added bonus.
You may also look for names like Constellation Brands, another alcohol company that has a mature brand portfolio, but which is moving into the cannabis sector, given its recent purchase of Canopy Growth, a cannabis conglomerate in Canada. This would, for instance, give your investment a mix between steady mature cash flow security and future growth.
Think about the growth of internet names in the last decade. Tencent, Alibaba, Google, Microsoft, Air BNB – all these names that we know very well have created different niche business opportunities and scaled their delivery to massive numbers of eyeballs. The growth potential here is massive, and while earnings can be very volatile with higher risk, these companies have given investors superb returns and have been very popular.
Perhaps you may think some of these names have become too big and are getting to expensive? In this case, it may be interesting to continue looking for options in the internet space, from alternative blockchain to other tech names like Zoom, Uber and Slack, which offer a brighter future and more opportunity to make returns.
Not All Risks Were Born Equal
There are also different styles of investing to consider.
Firstly, you should consider the degree to which you believe financial experts can create greater than normal returns. Investors who want to have professional money managers carefully select their holdings will be interested in active management, but it does come with fees. Some investors doubt the abilities of active managers in their quest for outsized returns. This position rests primarily on empirical research, which shows that, over the long run, many passive funds earn better returns for their investors than similarly actively managed funds. Passively managed funds have a built-in advantage: since they do not require researchers, fund expenses are often very low.
Secondly, you must consider whether you prefer to invest in fast-growing firms or under-priced industry leaders. The growth style of investing looks for firms that have high earnings growth rates, high return on equity, high-profit margins and low dividend yields. The idea is that if a firm has all of these characteristics, it is often an innovator in its field and making lots of money. It is thus growing very quickly and reinvesting most or all of its earnings to fuel continued growth. The value style of investing is focused on buying a strong firm at a good price. Thus, analysts look for a low price-to-earnings ratio, low price-to-sales ratio, and generally a higher dividend yield. The main ratios for the value style show how this style is very concerned about the price at which investors buy-in.
This may sound overly complicated but think of it like buying a pen; you have the choice of buying a Montblanc, a wonderful luxury asset, at $20,000, or a Bic biro for $0.20. They both have the same function and but there’s an incredible difference in perceived value. There are many tools and commentary, easily found on Yahoo Finance or other free resources, to help you decide for yourself with a particular company.
When Size Matters
Lastly, you must decide between either small or large companies. The measurement of a company’s size is called “market capitalisation” – the number of shares of stock a company has outstanding, multiplied by the share price. Some investors feel that small cap companies should be able to deliver better returns because they have greater opportunities for growth and are more agile. However, the potential for greater returns in small caps comes with greater risk. Among other things, smaller firms have fewer resources and often have less diversified business lines. Share prices can vary much more widely, causing large gains or large losses. Thus, investors must be comfortable with taking on this additional level of risk if they want to tap into the potential for greater returns. More risk-averse investors may find greater comfort in more dependable large cap stocks.
My last bit of advice is to also not put all your eggs into one basket and to build a portfolio of stocks and ETFs. This typically maximizes factors such as expected return and minimizes costs like financial risk. This sounds overly complicated but really, it’s a way of playing a number of themes that balance each other out. For example, when the markets have a weak day, the higher, riskier tech stocks that have already delivered super returns for investors may get sold down and you may see more cautious sectors like telco and utility companies perform. These are good options to hold because they offer protection, less risk and normally pay a dividend to attract investment, given that they are not as attractive growth-wise.
Few investments come without risk. The ones with the greatest risk stand to bring the greatest gains, but also the greatest loses. Understand that returns will rise and fall over the years, and the long run usually brings the best returns. Happy trading.
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