So you want to invest in the stock market. You’ve gotten your broker accounts all set up and you been reading around a little. The next step is to carry out some more focused research to help you decide which stocks are right to add to your portfolio of investments.
You should have your investments goals and restraints identified by this point – are you investing for the long term, such as for retirement or for a short term need? Do you have a lot of money free to invest in the stock market or limited funds? Have you got the personality to stomach investing in volatile areas of the stock market or do prefer slow and steady performers?
These are the types of parameters you should have already established and keep in mind when carrying out your research.
Investing In Stocks: Historical Performance
There are a few key indicators that can help you decide when investing in stocks. Start by taking a look at the historical performance of the stock price. This can help demonstrate both the success of the business in making profits, and investor sentiment in that stock. If the stock moves up and down sharply and frequently you can tell that this stock is very volatile and one in which investors have limited confidence in. On a good day this might be a stellar choice, but equally likely a bad day may lead to huge losses. These types of stocks are not right for conservative investors.
However if the stock price posses a historical pattern of steady growth this indicates that the business is being run well and that investor confidence is growing in this business consistently. It is most likely that returns will be small over the short term in this case but gains can add up substantially over a long term horizon and there will be a much lower risk of losing your money altogether.
Investing In Stocks: Size
Next, take a look at the market capitalisation, often known as the size of the company. Larger market cap stocks come with slow, steady and stable returns. At the same time smaller market cap stocks come with higher levels of risk and the potential for some sharp gains over the short term alongside the potential for sharp and severe losses to your money.
Investing In Stocks: Technical analysis vs Fundamental Analysis
Technical analysis is the term used for a stock picking strategy that is based on price and volume information of a particular equity listing in the stock market. By looking at the charts of price and volume performance alone, this analysis focuses purely on statistics and market behaviour. It assumes all other information has already been incorporated into the market price.
Technical analysis involves a lot of discipline and is the less favourable approach for most investors looking to generate returns over the longer-term horizon and who are not looking to take on any unnecessary risks.
Fundamental Analysis, on the other hand, is about the business and economic factors that affect the company and its ability to make profits. When this strategy is applied, it is called value investing. There are some techniques that can be applied in this area – these are called valuation methods, and the three most popular examples are explained here.
Investing In Stocks: Price to earnings (P/E)
Look at a ratio known as price to earnings (P/E) to help decide if a stock is a good investment. Price is the current stock price in the market, and earnings refer to the net profit reported over the last quarter per share.
For example, if a company’s stock is currently trading at S$50 a share and earnings over the last 12 months were S$2 per share, the P/E ratio for the stock would be 25.
To understand if the company is a good investment or not you need to calculate the same figure for some different companies in the sector. Say that we were just talking about a share of Coca-Cola in our example; the next step would be to calculate the P/E of other soft drink companies such as Pepsi. A high P/E for a company compared to its competitors indicates that investors are expecting higher earnings growth in the future for that company compared to those with a lower P/E. Note that the average market P/E ratio is 20-25.
Investing In Stocks: Price to book (P/B)
Calculate the ratio of share price to book value. This indicator helps you see if a stock is a right choice for your money. It is calculated by dividing the most recent share price of the stock by the latest quarter’s book value per share.
Book value is a term used to describe the value of the business today. It is the price that the company get today if it sold every asset it owns at the current moment in time.
A lower P/B ratio can be a signal that a stock is a good opportunity to buy – as it is undervalued and its price is too low. However, conversely, it can also mean that there is something wrong with the company – this can vary by industry and like with P/E you have to calculate the ratio for the companies within the same sector to identify if your stock pick will be a fruitful one.
Investing In Stocks: Discounted cash flow
Discounted cash flow is one of the most frequently used methods for professionals in the fund management industry. Of course, it does not mean it is too complicated for you and me to apply to our investments. The basis of this method is to estimate the cash flows the company expects to achieve over coming years and to discount and sum them to their current value to see what the company is worth today on a per share basis.
If this calculated value is higher than the current share price, then the stock might be a good opportunity to buy. The problem with this method is that estimating the potential cash flows for the business over time can be difficult and often inaccurate – making the final assessment fairly unreliable.
Read here to find out more on how to start investing in stocks.Recommend0 recommendationsPublished in