Sunday, 11 October 2009

What is a Stocks Portfolio?

Have you ever heard experts on TV talking about a stocks portfolio and wondered what exactly that is? Well it's quite a simple concept. A stocks portfolio is simply the collective term for all the stocks that you own. Every investment you have made can be thought of as being in one big group which is your portfolio. Have you ever heard the term diversify your portfolio? This is simply in reference to the logic that you shouldn't put all your eggs in one basket. You want to keep the stocks you buy spread across different companies and industries so that if one takes a hit the rest of your shares won't be affected by a sharp decline in value. For example if you had a large amount of stocks three different airlines and one has an accident all three will no doubt be affected in their value. Industries tend to be affected by events like this even if it isn't the company you own who had the accident. Investor confidence is fragile at the best of times and all those affiliated with the airline industry would feel the after shock of this. So to diversify your stock is simply an insurance policy you can take out yourself to make sure all your bases are covered.

Warren Buffett
has a slightly different opinion to diversifying your portfolio. Rather than buying up stocks from 20 different industries he has tended to focus on those he is familiar with and ensure you're buying in to good companies in the first place. Anything major like my airline example above won't affect the companies profitability in the long run and can be seen as a minor blip in the chart. I've also read a few articles where he's recommended buying more stocks in a company you already own rather than branching out and investing elsewhere. Now by this I'm sure Warren Buffett isn't recommending that you don't diversify your stocks, simply that if you have a good company there's no reason not to invest more money in to it. We are after all trying to make money from buying stocks and shares. There's a lot of websites out there from people claiming to have stock guru portfolios and I'm not even sure what that term is. I'm always wary of taking advice from someone who's claiming to be a stock guru, the proof is in the pudding as far as I'm concerned. I'll listen to people who have proven themselves over decades such as Warren Buffett who could actually claim to have a stock guru portfolio!

I've recommended quite a few times on this site about trying out fantasy stock markets online to get a feel for buying stocks for beginners. It's a great way to try out the industry and see if you're getting the hang of it without putting any money out. No risk attached. It's also a great way to get your head around the idea of having a portfolio and managing it, it would be a mock portfolio or practice portfolio. Most of the fantasy stock market games will let you browse stocks by industry and you can then see if you've bought stocks which covers a wide variety of industries protecting you from any downturn. This way if you diversify your stocks you won't get hit across all your holdings. If you do eventually decide to buy stocks online for real you'll be able to manage them in much the same way. Many of the online brokers provide excellent stock management software where you can get at a glance figures and stats per industry. Remember Warren Buffett's tactic though, don't invest in an industry you don't have any knowledge of! It makes it much more difficult to work out if it's a valuable company to invest in. If you're interested in this have a look at how to work out the intrinsic value of a company.

Saturday, 10 October 2009

Looking at the Intrinsic Value of a Company

I don't think I've covered a basic introduction to the stock market or the intrinsic value of a company in any of my posts so far so I'll run through some simple terms so we're all comfortable! I know the stock market can be confusing for lots of people out there including myself. When I first started out buying stocks and shares I felt like there was no way I'd ever get a good handle on what all the terms mean and the TV shows move so quickly. The hosts often assume you know what they're talking about and so skip over what each term means and leaves viewers (like me) even more confused and disheartened by the whole process! How can I work out which stocks to buy if I don't know what they're talking about! I know a lot of people out there look at the stock market as a form of gambling. Take a leap of faith to today on a hot stock pick and then sell it again the next day making a nice little profit! Yes that is gambling and it's something I'm telling my readers not to do. There's no science behind this process you're relying on hunches and luck and to be brutally honest the market doesn't care about you or your money. There's no one out there determining if its your lucky day so do your research! Don't take any leap of faith with your cash. I know I don't, I like mine too much to throw it away on Jimmy McShoes warehouse stocks!

So we've agreed we're not going to gamble right? So we're looking for long term investments. The next question is how do we identify a long term investment. The secret to this is working out the real or intrinsic value of a company. By this I mean you should be able to look at a companies balance sheet and work out if it's worth $40 a stock or $1 a stock regardless of what the market is. Once you work out a companies true value you can spot bargains and snap up the hot stocks. You won't have to sit and listen to the TV hosts recommending whatever the buzz stock is as you'll have your own research and analysis to call on. It's much more satisfying knowing you've done the research and watching that share price rise and rise over the years. Yes I said years! Buy and hold. Buying stocks just to dump them the next day won't make you any serious money in the long term. You'll end up losing large amounts of it by all the trading fees the stock brokers charge you for each transaction. This is of course all relative to the amount of money you're investing but if you're just starting out I don't imagine you'll have bags of money to throw at this. That's why it's so important to have done your research and make your stock and share choices wisely. Oh and diversify your stocks portfolio!

The dividends a company is paying out each year is a good indication of what profit it is actually making. John Burr Williams is a famous investor who recognized that a companies intrinsic value is key to determining the worth of stock. He famously stated that earnings are only a means to an end, and the means should not be mistaken for the end. A stock derives its value from its dividends, not its earnings. In summary a stock is only worth what you can get out of it. If it's not showing any returns is it worth buying? A stock is only worth the returns it will generate for you. You can get all this information from the companies balance sheet which is available for free in most cases from the company itself. How to buy stocks for beginners can be confusing especially when starting out but companies balance sheets are generally easy to follow. Unfortunately calculating the intrinsic value of a company will spark a debate between investors as there is no 100% perfect way of doing it as some of it is based on projected earnings which as you can imagine is never going to be perfect. There is software out there that will do this for you but it won't be any more accurate than doing it yourself. It will only act as a time saver. Make sure you read up on the software before you buy it too as you never know how they are calculating the intrinsic value. It might be completely different from the way you have found to value a company and so you may end up buying stocks that are not worth the price. We're interested in value investing after all and looking for undervalued stocks to buy.

Thursday, 1 October 2009

Stock Market Trading

Stock Market Trading for beginners ties in with the whole theme of this site which is to educate newcomers out there to the world of stocks and shares. When people want to learn how to trade on the stock market they generally think that you have to start looking at charts and stock tickers to find the hot stock. This only one part of buying stocks for beginners and it's certainly not a place I would recommend someone should start. It doesn't matter what reasons you have for wanting to get into the stock market whether it be to boost your retirement fund or just for the fun of it I don't believe anyone should just jump in blindly without doing a bit of research first. I've always thought that buying shares is a bit like gambling. You should never gamble what you can't afford to lose so don't be out re-mortgaging your house to buy whatever the hot stock of the week is. The idea behind Ben Graham's Security Analysis and the development of the value investment approach so successfully applied by Warren Buffett is that they take the gambling aspect completely out of the picture. Research is done so thoroughly that it's as close to a sure thing as you're ever likely to get.

If you are a beginner to stock market trading then you might feel swamped with information at this point. There is so much of it out there that you'll be left wondering where on earth you can start. You can buy online stock so easily and quickly now. The cost of buying stock has come down considerably too with all the competition out there from online stock traders. This should not be seen as a green light to go nuts and buy every penny stock in sight! I would always recommend using the value investing techniques described by Warren Buffett. He describes buying shares as being more like buying into a business. Try to look at buying stock as becoming a partner, albeit a very small partner, in a business. That way you may stop yourself from acting emotionally and dumping your stocks at the first sign of trouble.

Stock market trading for beginners is also very tough because of all the investing jargon used out there. I've covered the differences between bull and bear markets in a previous post so that may be a good place for you start. It's one of the simplest concepts to learn but I always feel that if you get the basics learned it will help you later on with the more difficult concepts. Your brain will have some hooks with with to cling on to when I start talking about price to earning ratio and its like! Websites like MarketWatch are good places to start. I've also found a lot of useful information on the Motley Fool website which also as a great forum with lots of people willing to chip in if you're stuck with understanding some stocks term. I would never take direct advice from someone in a forum regarding hot stocks. You never know why someone could be recommending stocks to you and if it was so great believe me they'd be buying it themselves rather than offering you up the chance to share in the spoils. I'd always recommend spending a good few weeks just reading over these sites and familiarising yourself with the jargon. Introduce yourself in the forum and get to know the users. The library is also a great place to go for more in depth information. Please check out Ben Graham's Security Analysis as a starter. Yes it is a bit of a slog but its the closest thing we investors have to a Bible!

To help you stock market trading beginners out he's a few basic terms explained. First up, what actually is a broker? You'll have heard it a hundred times already. A broker is short for a stockbroker and that is simply someone who carries out stock transactions. This is buying or selling stocks. You get all different types including full-service, online and auto-trade. They work for you to buy and sell your stocks. Dividends are something you'll be hopefully be seeing lots of! If a company you own stocks for makes a profit, shareholders are entitled to receive a bonus payment which is a percentage of this profit. You as the stockholder can choose to keep this money or reinvest it back into the company which will increase your percentage of stock. Futures can be a bit tricker to understand. Futures are purchased with the price of future commodities in mind. If the price of a commodity a future is purchased on increases in time, the investor will earn money. Alternatively, if the price of the commodity drops below what the investor originally paid the investor loses money. Confused? Don't worry about it the penny will drop eventually! Day Traders are people who I don't really understand but if they're making a killing on the stock market who am I to argue. Rather than keep stocks for the long term they buy and sell constantly with the aim of making small profit margins which all add up to big profits. This totally goes against the grain of Warren Buffett's value investing theory and mine too! Too much risk involved in day trading for my liking. Trading on margin involves buying stocks for a for a small fraction of the total cost of the share. The balance of the price is paid when the share is sold or on a subsequent date. Trading on margin could be compared to stock trading, it's very similar, with the exception that borrowed money is used rather than payment in full at the time of purchase.

These are a few basic terms which should help stock market trading beginners out there. They are obviously pretty simplified but hopefully I've made it easier to understand but still with enough detail that it's still useful. The stock market is a complex thing so don't get too frustrated if you can't grasp all the jargon right away. Also don't try and read everything out there as you might find all the concepts contradict each other! You've seen it all ready with day trading and value investing. It's far more important at this stage that you understand the basic terms and then you can dive in to the different investing approaches and decide which one is for you. You might find that a combination of two works! It's entirely up to you how you approach stock market trading!