From our previous lessons, “Fundamentals of the Stock Investing” and “Myth 1: Only Experts can make money the stock market” we now understand what a stock is and some of the basic terminology surrounding the stock markets. If you have done any more of your own research up to this point, you will have certainly realized that there are thousands of companies out there whose stock you can invest in. It’s almost overwhelming, I mean how do I know what company I should invest in? Like all important decisions in life you need to perform your due diligence and research before you make any moves.
Looking at stocks is like picking a restaurant that you are going to take your significant other to for one of your first dates. There are SO many decisions that you could make and thousands of restaurants out there. If you are not careful you could end up at a place that’s a small step up from Taco Bell in looks and provides you with just as much diarrhea. Not exactly an ideal date night. So what do you do? You start looking at places on yelp, check out some reviews, go to the restaurant’s website to check out their menu, look at some pictures online to see what kind of setting you’ll be in, everything. You cover all bases and pick the best one based off your research. The same can be done with stock trading! Unfortunately, there’s no yelp in the stock market world but in this article I’m to be giving you some resources you can use to begin your research. First, let’s go over some common pitfalls when it comes to picking stocks.
- Buy and Hold (Hope)
I wanted to talk about what 99% of typical investors do when they first enter the market. A strategy I like to refer to as Buy and Hope. These investors typically buy a stock that they personally like, maybe because of the brand or what they think it will do in the future, and then they hold it for years hoping that its value will go up. People blindly buy stocks without doing any research on them and pray that they magically climb hundreds of dollars. They are also emotionally tied to these stocks because they picked them out of personal interest. This causes them to go through a good deal of stress when they see the value of their stock fluctuating up and down and it can cause them to make irrational decisions. Such decisions involve holding onto the stock too long even though it is losing considerable value.
This would be like if you loved Michael Kors products and bought them all the time. You have no idea how the company has been performing financially over the years but you decide to invest 1k in their stock anyway, hoping it will go up. If this is your mindset you might as well take your money and head to Vegas because at that point you are just gambling. At least you will have a swanky purse while you lose all your money.
- Timing the Market
Many people believe that they can time the market. When I say this I mean they think can call the lows and highs of stocks to get in at a good price. THIS IS IMPOSSIBLE. In my time as a broker I talked with many clients who would tell me that they are waiting for the market to come down off its high before they were ready to invest. Often times I would look at their account and realize they had been sitting in cash since 2008! That’s 8 years of bull markets (continued upward trend in prices) that they missed out on.
- Hot Stock Tips
Other people blindly follow the heard or a “hot new stock tip”. What typically happens is a stock or the market as a whole will have a big upswing. Prices are rising fast, lots of people are making money, and the media is buzzing about it. The media likes to prey on investors emotions. The typical investor will see this and say “I am missing out!” and then proceed to buy at the peak of this upswing. Then everything starts coming back down (remember the stock market is cyclical just like the economy) and that same investor panics because he has lost so much money and sells out, taking a huge loss. This happens over and over again till that investor is wiped out of cash.
“Be fearful when others are greedy, and be greedy when others are fearful” -Warren Buffet
So those are 3 common mistakes people make when they first get into trading. Don’t be that investor! Let’s get into some ways to help you make smart decisions. All of the resources I am going to give you fall under a category called fundamental analysis.
Fundamental Analysis involves understanding the company’s health, competitors, and market in which it obtains it revenue. Now this might seem like a daunting task to have to look up all this information. You might say, “Nick I don’t have the time to do that.” Well good! Because neither do I but luckily these companies HAVE to disclose all of this information to you in one document called a 10k. Before you check out this document and invest even a penny, I want you to ask yourself 5 key questions:
- How does this company make money?
If you know what a company does and what it sells to make most of its money, you are more prepared to anticipate how it will perform in the future. For instance, let’s say you are considering investing in Procter and Gamble or Marriot Hotels. Procter and Gamble makes most of its revenues off of selling common household necessities like toothpaste while Marriott, of course, makes most of its revenues from selling hotel rooms. The U.S. economy starts heading into a recession and soon Marriott struggles to make more money because people have less disposable income to spend on luxury items such as traveling. Proctor and Gamble still sees decent sales in its products because it is not as greatly affected by this recession. In this case the better decision would be to invest in Proctor and Gamble because Marriott is likely to see its share price drop more dramatically during the recession.
When you start to think about a company’s fundamentals you want to know how that company has been performing in its industry and with the economy as a whole. Remember that the economy is cyclical and we will have ups and downs. Stocks that underperform when the economy goes down are said to be cyclical stocks. Stocks that still do well during down economic times are said to be defensive stocks. Often these companies are ones that sell durable goods such as toilet paper, toothpaste, food, and tobacco. These are things that we have to buy no matter if the country is in a recession or not.
For another example, let’s say the economy is doing just fine and you are contemplating buying some Samsung stock. How does Samsung make most of their money? By selling electronic devices such as the galaxy phone. Recently, the galaxy phone was blowing people’s faces off so they had to recall the whole line. This caused Samsung stock to plummet while Apple Stock rose because the IPhone is a direct competitor (AND their phones haven’t blown up…yet).
- What Industry is it in?
A stock is going to be categorized in a certain industry and sector as we talked about in the last lesson. Energy, Healthcare, Financials, you name it. Certain industries can be affected by the economic cycle or even laws that get passed by the government. For example, let’s say Hillary Clinton gets elected as the next president and she passes a bill that limits health care companies on what they can charge for their products. The entire healthcare sector of stocks would go down because of this.
You can also compare stocks within the same industry to see which ones are performing better. For example, let’s say the U.S. economy is doing well and you want to invest in a nice retail company. The retail sector has been performing better than the overall market in the past six months. You look at Nike and compare that company to Under Armor. From the comparison you see that Nike’s stock price has risen considerably more than Under Armor and they have much more revenues that have been increasing every quarter. In addition, Nike has launched a new advertising campaign that is expected to generate 1.3 billion in profits in the future. In this case Nike seems like the better stock to invest in.
- What are companies that I know the most about?
One of the biggest things you have to understand is that you don’t need to know 1000 companies inside and out to be successful in the stock market. Just starting out I would recommend focusing on a handful of companies that you already know well and understand. Companies whose business model makes sense to you. Often times these can be companies from an industry you work in. For instance, I work in IT now and I know a lot more about tech companies like Microsoft because I sell their product on a daily basis.
When you know what these companies do you can better anticipate how they will perform in the future. Let’s take Netflix for example because most of the world knows that company. When you read articles about Netflix or what’s going on in the world you know how it could potentially affect them in a negative or positive way.
- What’s going on in the market TODAY?
One of the first things I recommend to people as they get into trading is to get into a habit of reading news and watching how the stock market reacts. Remember in our last article we talked about how an Index is an aggregate of many stocks combined? (The Dow Jones is 30 nationally traded companies). These indexes such as the Dow Jones and S&P 500 are going to give you a good feel of how news and economic events drive the markets.
For example, when London went through the Brexit, the Dow Jones was down over 400 points. You do not need a degree in economics to understand how these events will cause the market to shift. With time you will begin to see that the market moves in patterns. Some people don’t know that as a stock broker, I watched the market all day from open to close for over a year. By no means am I saying you will have to watch it so intently to learn. I believe that just taking 10 min out of day to look into how news is driving the market will greatly improve how you trade (Mr. Miyagi effect). How many minutes do you spend on snapchat taking pictures of yourself with 10 different filters? Take 10 of those minutes and devote that time to learning.
- Where are the opportunities?
The goal of trading is to be one step ahead of the market. Constantly ask yourself, who is the next Apple? The next Facebook? When a company comes out with a new product ask yourself, how profitable can this be? How big is the market for this product? A great example of this most recently is the launch of Pokémon GO. The first day after the weekend that the app launched, Nintendo stock jumped an astounding 63%, raising the companies value by approximately 11 billion. If you invested in that stock that week alone, you would have almost 100% on your investment. Instead, you ran around, caught 6547943 rattata’s, and cried yourself to sleep. The point is to always keep your eyes open for the next great company that you could profit from.
Tools at Your Disposal
The internet is going to be a great source for you starting out in doing research on a company. Many financial websites have company descriptions as well has up-to-date news articles about any announcements that have come out about the company lately. You can find a ton just by going to the actual company website itself. When you open a brokerage account, the firm will often have some kind of research section available to go and look up information on individual stocks as well. Investing in companies whose business model you understand can give you a great advantage before you do any further research.
Fundamental analysis and asking these 5 questions is only one piece of the puzzle when doing your due diligence on a company. Think about it. Let’s say you do all this research and have a company that you really think will perform well in the future. Are you just going to buy in now at whatever its trading at? That seems like you’re still speculating a lot on this trade right? To fill in the gaps we also need to take a look into something called technical analysis which I will be discussing in my next article so stay tuned!
Homework: Think of 5 companies that you know very well and look to see how well their stock has been performing lately. Think deeply about their products/services and try to understand how they can become profitable in the future.