It is common for people to enquire about selecting a broker as the first step to investing in stocks, especially if they are new to the game.
But that is not the first step, nor is it a key success factor to stock investing.
Here are things people need to know to succeed in stock investing, which should be considered even before opening a stock brokerage account.
1. What is stock investing?
Many people do not actually know what stock investing is so they tend to buy, hold and sell shares aimlessly.
It is helpful to assess the purpose in investing the stock market. Is it build up a nice portfolio, to grow wealth sustainably for the long term or because someone thinks the stock market offers a chance to make a quick buck?
Many people regard themselves as investors but they are actually just trading or speculating in stocks.
They do not know the difference between an investor, a trader and a speculator. In brief:
An investor aims to build wealth by amassing shares in good businesses.
A trader aims to make a quick buck from fluctuations in stock prices.
A speculator is like a trader without a trading plan who relies solely on luck.
The tips that follow here are designed for those who want to be an investor.
2. What are the investment objectives?
Isn’t it to make money? Not quite.
Investors aim to protect or to increase the purchasing power of their money while earning a passive income stream from their portfolio.
The focus is on accumulating income-producing stocks that act as stores of value, the preferred method of building and storing wealth in the long run.
Answering the questions below might bring some clarity.
- Are you in it for the long or the short term?
- Are you in it for the money or to build wealth for the long term?
- Would you like to receive dividend income year after year for the long term?
The answers will help determine which stocks to buy, how many to buy and what to pay for them, and what to do if the stocks move up, down or even sideways in the future.
3. What is a good stock?
There are 900+ stocks listed on Bursa Malaysia. How does one identify a good stock to invest in or a bad one to avoid?
By not thinking through Questions 1 and 2, chances are, the individual will not have a game plan to profit from the stock market. They are not investing but gambling.
No one can tell someone how they should invest, but from personal experience, converting some ringgit into a more stable currency, such as the Singapore dollar, helps to store wealth.
But instead of having the Singapore dollars in bank accounts or fixed deposits (FDs), stocks listed on the Singapore exchange would earn dividend income in Singapore dollars and grow wealth as the businesses of these stocks continue to grow over time. In summary the investment strategy is:
- Earn dividends in Singapore dollars, which is higher than FDs in Malaysia and Singapore.
- Store wealth in Singapore dollars to protect against a fall in the value of the ringgit, if it happens.
- Compound wealth as businesses continue to expand and grow in the future.
It is necessary to find stocks that fulfil these objectives, fundamentally good stocks that have robust business models, have delivered consistent growth in profit and dividends and have tangible plans to sustain growth in the future.
Each individual must decide what they consider a good stock. Is it easily defined? If not, think things through before investing.
4. What is a good price for a good stock?
An investment is only good if the stock is good and bought at a good price. What is a good price? How to tell if a stock is overvalued, fairly priced or undervalued?
Three valuation ratios can help determine if a stock is correctly priced.
- Price-to-earnings ratio (PER): Comparing the stock price relative to its earnings.
- Price-to-book (P/B) ratio: Comparing the stock price relative to its net asset value.
- Dividend yields: Comparing the stock price relative to its dividends.
It is important to learn how to use these valuation ratios before putting one’s money into the stock market. Otherwise, a person could end up buying overpriced stocks because they cannot tell if a stock is cheap or expensive.
5. Which stocks should be on a watch list?
An investor should build and maintain a watch list of about 50 stocks. A good stock that is overpriced today may become undervalued in the future.
No one knows when this will happen and having a watch list allows one to keep track of these stocks.
It enables investors to make better and timelier investment decisions over the long term.
Conclusion: Are you ready to invest in stocks?
Someone who cannot tell the difference between an investor, a trader and a speculator; does not have a game plan; cannot tell a good stock from a bad one or if it is cheap or expensive; and does not have a watch list is clearly far from ready to invest in the stock market.
The best is to invest money, time and effort to get educated first. Many people incur losses and waste time buying bad stocks as a result of a lack of education.
This article first appeared in kclau.com
Ian Tai is a financial content machine, dividend investor and author of over 450 articles on finance featured in KCLau.com in Malaysia, and ‘Fifth Person’, ‘Value Invest Asia’, and ‘Small Cap Asia’ in Singapore. He is a regular host and presenter of a weekly financial webinar with KCLau.com.