Friday, March 20, 2009

Buying Stocks For Beginners - Back To Basics

The beginner stock market investor could be forgiven for thinking that the end of the world is nigh. With share prices having fallen dramatically the world over and the economies of most developed nations entering or already in recession things certainly do look grim. That's why I thought it was time to put together another "how to buy stocks for beginners" type of post.

So lets get back to basics. When you purchase shares in a publicly traded company, what does it mean? Well the first point I'd make is that your investment is more than just a number next to a stock symbol on the Yahoo Finance website (or whatever financial website you prefer). Your investment represents ownership of a portion of a real business. That ownership entitles you to a share of that business's future profits.

This is a very important concept to grasp. Don't be taken in by the daily fluctuations of share prices. These prices are driven by investor sentiment, by a bunch of people trying to guess what the future may hold. The rate at which these prices change belies the stability of the underlying value of your investment. The value of the business - your business - doesn't change that quickly. Sure there are times when a company makes an announcement about a fundamental change in their operations which may cause the price to plummet. But more often than not, it's just the general mood of investors pushing prices up and down.

Don't get me wrong - I'm not suggesting that we can ignore the current economic problems. But by the same token, don't let the current gloom and doom terrify you to the extent that you're willing to ignore quality companies trading at bargain basement prices just because you don't know if the stock market has bottomed yet.

That brings me nicely to my next point. I'm a firm believer in buying stock for the long term. One of the advantages of this approach is that it frees up your mind from worrying about the day to day gyrations of the stock market. By fixing your eyes firmly on a point 3 to 5 years (or even longer) down the track, you can afford not to worry about what your shares will be selling at next week or next month. You'll be able to focus on what really matters - watching the business, making sure it continues to perform as you expected when you bought it.

However, in order to do this you'll first have to put some effort into learning how to understand stock market concepts. Learn how to read a company's financial statements. Compare profitability ratios with those of it's competitors. Consider the financial strength of the company - does it have excessive debt and will it be able to make the interest payments on that debt?

There are a number of very good books available on investing in the stock market. I wrote a post some time ago about what I thought were some of the best investment books for beginners. The books mentioned in that post are all very good and well worth readying.

When To Buy Stocks

This is the essence of being a long term investor and is what I was alluding to before. If you're willing to take a long term view, you can afford to think more about the best stocks to buy rather than the best time to buy stocks. Accept that you wont pick the bottom. There's every chance that prices may go lower. However, if you're happy that you've bought stock in a good quality business who's earnings are going to grow over the long term, you'll be able to ignore the short term price movements. If it's any consolation, you probably wont pick the top either.

I think if you can remove this focus on short term results, you will remove one of the biggest impediments to beginners buying stock.