Image by: Terence Wright
By Michael Sterling
The stock market doesn’t have to be an intimidating venture. Investing is something that most men need to know how to do these days. Saving for retirement and building your personal net worth has become a necessity. The last thing you want to do is get left behind, so if you want to truly know how to invest in stocks, pay attention to these 5 crucial tips:
#1) Never Judge a Stock By its Price
The true value of a stock depends on the company’s earnings. For example, a $200 stock might be cheap if the company’s earnings prospects are high enough. At the same time, a $5 stock can be expensive if earnings prospects potential is minimal. The secret is comparing its price to the company’s revenue, earnings, cash flow, and other factors.
A smart investor knows the power of comparison, especially with other companies in the same industry. Slow-growth industries are typically looked at differently than companies whose sectors are more consistent. Think of it as dissecting the specimen. Every detail within a company’s infrastructure defines its potential. Never mind what it looks like on the outside.
#2) Long-Term will Always Bring a Return
Investing in stocks as a long-term endeavor will always be successful. When things in the market turn positive, unless you have money in the pot, you’re never going to reap the rewards. What most people fail to understand is that as the economy grows, so will stock prices and corporate earnings.
According to CNN Money, since the mid-20s, an average large stock has returned close to 10% a year. For someone who’s money is safely tucked in the market all this time, that’s a pretty hefty retirement – much better than savings bonds.
Buying and holding good stocks are much better than trading when the going gets tough. Eventually, that stock will be worth much more than the value you would have gotten in a spontaneous trade.
#3) The Greater the Potential, the Bigger the Risk
Because there are thousands of stocks for investors to choose from, many beginners opt to go towards those companies who are rapidly expanding at an above-average rate. Today, in 2013, they tend to be tech or digital companies. When you catch a successful stock early on, the returns can be gigantic.
However, always remember that these “growth stocks” race higher when times are good, but whenever the growth slows down, the stocks will tank. On the opposite side of the coin, there are also investors who make a solid return by buying based on value over growth, believing the company’s true worth isn’t reflected in a declined stock price, but rather its infrastructure.
There is nearly no safety net when investing in stocks with high potential, either short-term or long-term, but the real test comes from the investor’s timing. The stock market’s growth is always going to be a reflection on the government’s economic strength. When you time your buying/trading right, you might manage to dodge epic failures.
#4) Think, Before You Buy
Only a fool will treat the stock market like a poker game. Whether times are good or bad, a stock’s worth is always going to be based on its valuation. This is where you need to focus your attention on. A simple way to discover a company’s valuation is by using three tools of calculation:
- Price/Evaluation ratio – This comes from dividing the current price per share by the earnings per share (either by the last four quarters or estimates for next year). This calculation is meant to tell you whether a stock is overvalued or undervalued.
- Price/Sales ratio – This comes from dividing the stock price by the total sales per share in the last year (or for the next fiscal year, to make accurate predictions, those numbers are frequently published on financial websites). P/S ratios are all over the map, but fast growers tend to get the highest valuations.
- Price/Book Value ratio – This is the stock price divided by the book value (a company’s total assets minus its total liabilities + intangible assets, i.e. the leftover assets after paying off all one’s creditors). This is a more conservative method investors use to spot cases in which the market is over or undervaluing a company’s true potential.
#5) Pick The Right Stocks For Your Portfolio
Picking the right stock for your collection is more than just a random choosing. Your portfolio should always consist of financially strong companies with above-average earnings growth. Typically, a well-balanced portfolio should hold 15 – 20 stocks, across seven to ten different industries, but you don’t need to buy them all at once.
By choosing stocks that offer a total return higher than the 10% historical market average, you will be able to hold your stocks for a long time. Statistically, high-growth stocks are overpriced and have a harder time meeting inflated expectations. Sculpt your portfolio to reach a 12 – 15% return over the next 10 – 20 years, and you will always have a solid return.