Stock Market Investing 101
If you’ve ever listened to any business or political news, you’ve probably heard about the stock market. The investing jargon and the various metrics mentioned such as PE, volatility, Market cap and IFRS might have even gone over your head. These are all very important terms for any investor to become familiar with BUT before that you want to have a basic understanding of what a stock is and what it means to be an investor in the stock market. That is the point of this article. We will be looking at three things the first time stock market investor needs to know before he puts his first dollar into a stock.
Number 1: If you buy stock in a company, you are a part owner in the business.
“Stocks are not lottery tickets” ~ Peter Lynch
If you buy stock in a business you are a part owner in the business. If you buy a stock you are buying into a business. So, you have to know what you are investing in.
Imagine someone comes to you and says, “Hey, I have a business and I’m selling you a part of it for 10,000 dollars.” At the very least you would ask the person what the business is. You’d want to know what the business makes or what service the business provides.
Now imagine the person says to you, “No no no, you don’t need to know all that. I’m just selling you a part of my business. All you have to do is give me 10,000 and it will be worth 20,000 next month.”
I trust I am not wrong in saying you’d tell this person to forget it. Unfortunately, that’s how many people invest their money when it comes to stocks.
They hear of a new company coming to the market, a new Initial Public Offering or IPO and without thinking they run to their brokers because they don’t want to miss out.Sponsored
I have fallen for this too BUT YOU won’t because you now have this article.
I’ve jumped into investments because I heard it was a sure fire way to double my money and I did not want to miss out. Well, as I, and many other investors have come to learn, this usually doesn’t work out.
In fact, the stock might go down as opposed to going up.
SO the first thing to remember in buying stocks is that the stock represents an ownership interest in a business and when you buy a stock you are buying into a business.
I cannot overstate this.
So here are three things we want to find out about any company before we buy the stock.
- We want to know what business the company is in and have an understanding of that business.
- We want to know that the company has a team leading it that can execute the company’s plans in a profitable way. AND LASTLY,
- We want to know whether the company is profitable and how the management plans to increase profitability.
Number 2: Stocks are typically for the long run.
Taken over a 15 to 20 year period, stocks have done better than any other type of asset in terms of growing wealth.
It has done better than real estate and commodities such as gold and silver. It has out performed bonds and other forms of government paper and it has certainly done better than cash.Advertisement
The key thing to remember though is that it takes time for us to see those returns. If we take time to think about it, this will seem less surprising.
Consider my first point, that a stock represents an ownership interest in a business. If the business does well, the stock tends to do well.
BUT, it takes time for a truly amazing business to come into its own. Think of companies like AMAZON, or FACEBOOK. It takes at least 10 Years for a great company to prove itself.
If you show me a business that has demonstrated growth in earnings for 10 consecutive years, there’s a chance you’ve found a great business.
The main point, I am making here is that we shouldn’t buy a stock with the expectation that the stock will double next month or next year. Peter Lynch says that “If you aren’t willing to own a stock for 10 years then you shouldn’t own it for 10 minutes.”
Now, a lot can change in 10 years but if we buy stocks in good businesses then the stock is quite possibly going to be better off in 10 years regardless of what is going on.
NUMBER 3: There are two ways we can earn money in the stock market AND two ways to lose money.
It would be plainly unfair if I did not tell you that it is possible to lose money in the stock market. Even without getting into margins and options trading, there are two ways you can lose money in the stock market. The first way is by selling stocks at a lower price than you originally bought them.
Now, You might say, Why would someone do that?? But there are legitimate reasons for doing that. I’ll get into this in another article so be sure to join our mailing list so you can get our weekly digest showing the latest articles. Also, please consider subscribing to the “Beyond The Stock Price YouTube Channel”
The second way we can lose our money in the stock market is if we buy stocks in a company and the company goes bankrupt.
For instance, if I invest in a company in its early stage and then the company is not able to make a profit, they will eventually run out of money. When that happens the company files bankruptcy and is liquidated.
If the company has any debts, they will have to be paid first, then the preference shareholders.
Once the debts and preference shareholders are paid, the ordinary shareholders will be paid…IF THERE IS ANYTHING LEFT, WHICH THERE USUALLY ISN’T.
The good news is that usually, an investor is able to see the writing on the wall for company’s heading down the road of bankruptcy from the annual reports. He is then able to make a decision either to sell his stocks at a loss or stick with the company until they turn around.
Even well established companies can be forced out of business by competition. There are many examples of companies, even very BIG companies that have gone out of business causing shareholders to lose money. Examples include, Leman Brothers, AIG, ENRON, Toys ‘R’ Us and Ciboney.
How does one make money from investing in the stock market?Sponsored
So enough bad news. On to how investors make money. I assume that is why you are reading this article, There are two primary ways, the first is through dividends.
When you buy stocks in a company, you are entitled to a a share of the company’s earnings. Remember, we are part owners. Management might decide to pay out some of the company’s earnings to its owners. In this case, it is called a dividend. The company will then send a check to the shareholders for the amount declared for each share that they have.
SO the amount you get is in proportion to the amount of stock you own. Let’s say that you own 100 units of APPLE stock and the management declares a dividend of ten cents per share. You will be sent a check for the sum of ten dollars ($0.10 per share times 100 shares = $10.00) minus the necessary taxes.
The second way is through what is known as capital appreciation! Remember earlier when I said that as a company grows, the price of the stock tens to go up as well? This is what we mean by capital appreciation. Stocks aren’t the only thing that can give you capital appreciation. If you buy a house for 1 million and it is revalued to 1.2 million then you have capital appreciation.
If you buy a stock for ten dollars per share ($10.00) and it goes up to twelve dollars ($12.00), say over the next two years, then you have made 20% in capital gains. It is important to know though that unless you sell the stock the money is not real. It what is called a paper gain or an unrealized gain. I will do another video on how capital gains can benefit the investor, even without selling the shares.
So to recap, the stock market is place where money can be earned or lost. Before we jump in though, we want to understand that by buying a stock, we are investing in a business. In the same way that you would not give your money away to just any person, you have to be careful when investing in the stock market. It is good to have an idea of the business you are investing in and how they make money. Lastly, as investors, we have to think long term, we are not looking to double our money overnight. It takes time for a company to grow.