This article shows how to be a successful investor like Warren Buffet. Understand the essentials to start investing successfully. Stock investing for beginners starts with knowing different types of stocks, and how to invest in stocks. What are good stock investments for beginners and find out the right stocks or investment strategy without needing to delve into books.
Warren Buffett is one of the most admired persons in the United States. Most people admire his humility, philanthropy, and his success in the financial market. For this reason, thousands of them make the annual pilgrimage to Omaha for his annual general meeting.
What is a Stock?
Many companies are in a constant need for money to invest into growth. To get funds, they can take debt from a financial institution like a bank. This debt will be paid back with interest within a certain duration. Alternatively, they can give equity to investors, who will own part of the company.
As the company grows, it could sell more equity to outside investors through a process known as Initial Public Offering (IPO). When an IPO happens, it becomes possible for individuals and institutions to buy a stake in the company. By owning a stock, you will make money when the share price appreciates or when the company issues a dividend.
Fact: In the United States, there are almost 4000 public companies. Apple is the biggest one with a market capitalization of more than $943 billion. It is followed by Microsoft and Amazon.
Types of Stocks
Stocks are classified in three main ways: size, industry and their stage.
Based on size, stocks can be classified as mega cap, large cap, mid cap, small cap, and penny stocks. Mega caps have a valuation of more than $100 billion while penny stocks have a market value of less than a million dollars. Penny stocks are really cheap stocks with mostly a very limited outlook.
Based on the industry, stocks could be classified as technology, financial, consumer staples, consumer discretionary, telecoms, energy, transports, utilities, and retail.
Based on their stage, stocks could be growth, value, or income stocks.
- Growth stocks are relatively young companies that are experiencing a lot of growth. Examples of growth stocks are companies like Tesla, Twilio, and Wayfair.
- Value stocks are relatively older companies that are trading at relatively lower valuations than their peers.
- Income stocks are those that offer a generous dividend.
How to Invest in Stocks
Identify the type of investor you are
To invest in stocks, you first need to understand the type of investor that you are. Broadly, there are three types of investors. Scalpers buy stocks within a few minutes. Their goal is to make a profit within a short duration by capitalizing on the breaking news and technical indicators.
Swing traders buy stocks and leave them for a few days while long-term investors buy stocks and leave them open for months and years.
There are merits and demerits of either of the three approaches. For example, being a scalper helps you cut the risk of negative news when the markets are closed.
Identify the type of stocks you would like
There are thousands of stocks you can invest in. In this stage, you should decide on the types of stocks that you are interested in. To do this, you should decide on whether you want to invest in a single industry like technology or in a diverse group of industries.
Based upon this, decide on the size of the companies you are interested in. For example, you can decide to invest in mid-cap retail companies like Target and Macy’s or in large-cap technology companies like Alphabet, Cisco, and Microsoft.
Screen the companies
To find potential investments, it is recommended that you use a free screening service such as that provided by YCharts, Yahoo Finance, and Barchat. These platforms will help you screen the companies based on your preferred criteria.
After identifying potential companies, you should start an in-depth research about them. The best way to start is to read its annual report, which is also known as the 10K. This report will give you all the details about the company. After this, you should read the most recent stories about the company in popular financial publications like Bloomberg, Financial Times, and Wall Street Journal.
This will give you a snapshot about the recent happenings in the company. Next, you should read the recent research about the company from sell-side analysts. You should also read the transcripts of the most recent earnings call. A good place to get started is Seeking Alpha, a website that offers crowdsourced investment research.
As an investor, your goal is to invest in a company that is reasonably valued. To set this up, investors use a number of models, with the most common one being multiple comparison. In this, you simply compare the company’s multiples with that of its peer group of companies. The most common multiples used are price-to-earnings, price-to-sales, and EBITDA-to-enterprise value. Ideally, companies in the same industry should have a similar multiple.
If company A has a forward PE ratio of 10 and its peer has a forward PE ratio of 15, it means that company A is undervalued. Your goal is to find why it is undervalued and whether there is a catalyst that will take it higher. To find this data, you should use platforms like YCharts, Yahoo Finance, and Morningstar.
Qualities of a Good Company
A good company has a number of qualities. These are the recommendations to identify if investing in a certain company is a match for you.
- Search for a company that you understand very well.
For example, it is very easy to understand how a company like Netflix makes money.
- The company should be in a growing industry.
For example, it is not advisable to invest in dying industries like coal, newspapers, and bookstores. In growth, you should look at how it is improving its top-line, bottom-line, and margins.
- The company should have a clean balance sheet.
This means that the company should have more assets than liabilities. It should not have a lot of debt. In the past, many heavily indebted companies like Sears and Toys-R-Us have been forced to declare bankruptcy.
- It should be generous to investors.
If you are a value investor, you want to invest in a company that returns money to the shareholders in form of dividends and share buybacks.
- The company should have an excellent management team.
This management team should not only be managers but stock owners of the company. In fact, a good way to find whether a company is a good investment is to look at the activities of the insiders.
- Look at a company with an excellent competitive advantage against its peers.
For example, in the e-commerce industry, a company like Amazon has a competitive advantage against its peers because of the Amazon Prime service, which has more than 100 million subscribers.
Selecting a Broker
Finally, you should now select a stock broker who will execute your orders. A good broker should be regulated by the Securities and Exchange Commission (SEC), have a proven track record in the industry, and have low costs.
The most common brokers you can use are Fidelity, TD Ameritrade, Charles Schwab, and Robinhood. Most young people such as college students prefer Robinhood because it does not have any transaction charges.
While investing in stocks can be intimidating at first, it has proven to be an interesting and rewarding experience. In fact, some of the wealthiest Americans like George Soros, Bill Ackman, David Einhorn, and John Poulson have made a fortune in Wall Street. You too can do it if you start small, take time to learn, and manage your risk well.
Kasper is our expert for saving, investing and bank accounts. Kasper holds an MSc in Mathematics and worked with Mercedes-Benz and the Dutch tax authorities.