If someone tells you they can guarantee stock or equity investing with absolutely no losses, then I grant you the permission to laugh and walk away. But not everything is doom and gloom, with the combination of long term targeting and fundamental disciplinary rules, you CAN generate profit and receive passive income out of stock investing. I know you are impatient to learn more about these rules, so I am going to explain you the steps of successful investing in 3 stages. Note that all the stages are essential to hold onto your conviction of long term investment. Stay with me to learn what to buy, when to buy and lastly, what to do once you bought the stock.
STAGE 1. WHAT TO BUY
STEP 1. Look for good and sound management
To put it in a simple way, the management team deals with the dividends and they are the ones who will give you your share. As a shareholder, you should be looking for a management team that has an active policy of reducing the number of outstanding shares. Why does it matter? Well, the less shares the company offers, the bigger your stake will be. This approach represents a greater percentage in the profit and assets of the business. Unfortunately, most management teams focus on building domain rather than increasing the wealth of shareholders. You certainly don’t want a management that pays exorbitant salaries and lots of perks just to itself. Instead, you should watch out for management who is merging their private companies with the ones you are looking to invest.
STEP 2. Look for a moat business
Moat is the competitive advantage that one company has over other companies of the same industry. In today’s world, it is easy to copy a product and a service of another company. So, our job is to identify companies with strong competitive advantage and be sure these companies are have the potential to exceed and will stay in the market. Some parameters you can use to identify good moat companies are net cash flow (NCF), high return on equity (ROE), and higher return on capital employed (ROCE). Examples of good moat companies that you might be familiar with, are Apple, Disney, Monsanto etc.
STEP 3. Watch out for the Dividend Yield and Dividend payout ratio
To you these might seem buzzwords but if you want to be a successful investor, you should be able to recognize them and define them in nanoseconds. I hate being like your middle school teachers, who made you learn definitions by heart but I’m sorry I have to. The Dividend Yield measures the cash dividend paid out to shareholders relative to the market value of share. Dividend yield is important for long term investors, who want to generate passive income while holding the stocks for a long term. As an investor, you need to check dividend paying track record and dividend growth of the company, along with sound management and moat business. Dividend payout ratio is the percentage of company’s earning paid out to investor. A little historical fact in this article full of terms: historically, dividends paying out stock with strong competitive edge (MOAT) have outperformed the market over time. Actually, there is a saying in the investment world – stock prices lie, dividends tell the truth. No bad business can pay rising dividends for a long period of time. That is why, I ensure you that dividend reflects the real positive energy and the potential of a company.
STEP 4. Look for Debt to Equity (DTE) ratio of a stock
Here comes another term: debt to equity ratio indicates company’s ability to repay its obligation. You can easily calculate it by dividing a company’s total liabilities by its stockholders’ equity. If the DTE you got is greater than 1, then stay away from that company because it does not indicate anything good.
These 4 steps teach you the very basics of investing in any stock. Great! Now you know what to buy, so the next question is when to buy? No magician can make maximum profit OR avoid losses without knowing when to buy, therefore keep reading to find out the perfect time of buying a stock.
STAGE 2. WHEN TO BUY
STEP 5. Look for Price to Earnings (PE) ratio of the company
The price-earnings ratio (P/E Ratio) is used to evaluate the current share price relative to its per-share earnings. The PE ratio between 8 to 16 is considered ideal for investment, but it should be compared with its peer competitors and only to those of the same sectors; otherwise it can give you a wrong picture of the company. Certain sectors have very high PE, while some sectors trade at a very low PE. PEs are unpredictable, sometimes they can stay high for longer than expected because market has a very high hope for this company’s future. Better roughly right than precisely wrong.
STEP 6. Look for Price to Book Value (PBV) ratio of the stock
And the list of terms goes on. Book value is the value of an asset in the company’s balance sheet, as simple as it is. A stock with price to book value less than 1, indicates that the stock is undervalued. It also states that there is something fundamentally wrong with the company. To be on the safe side, it is always advisable to compare this ratio with others. You might also need to check the difference between the historical price and the book value ratio.
Once you have found good companies with sound management, moat, low debt to equity ratio and with good dividend payout ratio, look for the Price to Earnings (PE) ratio and Price to Book Value .
Congratulations, you bought your stock. Now, do you just sit back and relax or is there more to do? Well, if you were planning to forget about your investments until the day of getting the income then I am sorry. There is one more stage, which is the most important one. Long term investment is more of a psychological and behavioural investment and that is why you have to implement all your rationalism and objectivity in this stage.
STAGE 3. WHAT TO DO ONCE YOU BUY STOCK
STEP 7. Buy Right and Sit Tight
“Men who can both be right and sit tight are uncommon”, said a legendary trader Jesse Livermore. Market swing can hit you hard and take you on a bumpy ride. Some investors might enjoy the returns from the best years, while most won’t be able to handle the worst. It is just the way it is. Keep in mind that the fall is not forever and market tends to rebound. Jumping in and out of stock frequently may cost your portfolio. Transaction fees and short term capital gain may eat larger portion of your profit percentage in longer run. I am sure, you don’t want to face such problems, so the longer you hold, the greater your chance for positive returns are. Market, Hedge funds, Financial Institution, operators and big sharks can be against your side but time is in your side and that is what makes all the difference.
STEP 8. Capitalize on Market Declines
Market crash is every investor’s worst nightmare and the reason why a lot of people step back and do not invest. In reality, it is a result of poor information and knowledge. You can use Market Decline in your favor. How? – Buy and capitalize. Buying while market’s down will help you for next upswing. Let’s throwback to post World War 2 period for a second. At this time, there have been many corrections of 8-10% every 18 months on average. Do not let Market Declines win you, instead use it to step up your investment game.
STEP 9. Stay away from business channels rumours, broker tips and research reports
Just because investment is connected to numbers, it does not mean it is 100% practical and logical. Investment can be emotional, especially when we are talking about a lot of money. Under such circumstances, it is easy to panic and get worried from every single thing you hear. Follow my advice, stay away from unreliable news channels, and websites of unknown origin. Their main goal is to create confusion among the investors. Do not let their loud talk win against your conviction.
STEP 10. Final checkpoints to consider
- Don’t sell because of small gains
- Know what you own and why you own it
- Overreaction is harmful to your long term investment goals
- Decisions are not based on media, TV rumours, and tips
- Don’t try to time the market
- Asset class performance varies from year to year