A beginners guide to investing in the stock market.
Before we get started you might like to review one of my earlier posts titled "Stock Market Investing - Is It For You?". In that article I discussed some of the things I think you should consider before diving into direct investment. Don't get me wrong - share market investing can be very profitable, but the market can be volatile and is no place for the faint-hearted. So you'll need to make sure you're well prepared before embarking on this journey.
I'd like to discuss stock selection today, but prior to that I should mention that there are a number of options you can use to gain exposure to equities without needing to choose individual stocks yourself. You could go for a Mutual Fund (either open-ended or closed) or maybe an Exchange Traded Fund (ETF). These types of investment typically hold publicly listed companies as the underlying investment, but by purchasing units or shares in one fund you gain exposure to a broad selection of companies. This negates the need for you to research each of the individual companies yourself. The fund employs a team of stock analysts who do the legwork for you. Mutual Funds and Exchange Traded Funds are quite often constructed around a particular theme (ie. value or growth) or around a particular market sector. These types of investments can be a good way to get your feet wet when you're just starting out or if you need help investing in the stock market.
Once you're ready to jump in and start buying individual companies directly, you'll need to make sure you've got your investment strategy sorted out. How are you going to go about selecting what stocks to buy? How many different stocks are you going to hold? How long are you going to hold a particular stock? Under what circumstances are you going to sell? You'll need to consider each of these questions. By having a plan in place, you'll be able to approach your investment activities in an organized and structured way. You'll be able to keep a cool head while everybody else is panicking. It's at times like these that your best opportunities may arise.
When it comes to investing in the stock market for beginners, my preference for picking stocks is to apply fundamental analysis. This involves rolling up your sleeves and actually learning about the company. A full treatment of fundamental analysis is a textbook in its own right but in short you'll need to delve into a company's return on equity, debt to equity, price to earnings ratio, dividend yield and so on. By understanding a company and its business in great detail you will give yourself every opportunity to make a good return on your investment. One of the best books I've read on this topic is The Intelligent Investor by Benjamin Graham.
Technical Analysis is another way that some people approach mainly short term investing in the stock market. I use the term investing loosely as I'm not a big believer in using technical analysis to make money in the share market over the long term. In a nutshell technical analysis is the use of price and volume data to predict future price movements of individual stocks or of equities markets as a whole. You'll read about terms such as charting, moving averages, resistance levels and RSI (relative strength index) among others. I won't dwell upon it here because in the past I haven't really used much in the way of technical analysis. Having said all that, I have been considering technical analysis as a way of timing the purchase of stocks which I plan to hold over the long term as I believe it may offer some insight into investor psychology.
There are almost as many systems for picking stocks as there are investors in the market, but most of them have their foundations in either fundamental or technical analysis. For example, the Dogs Of The Dow system (in its simplest form) advocates buying the cheapest stocks of the Dow Jones Industrial Average (DJIA) once per year. And in order to determine what is cheap, the fundamental statistics of each company is used as a yardstick.
I'll discuss more about this in my next post for which I think I'll use the incredibly creative title of Investing In The Stock Market - Part 2.
Friday, June 6, 2008
Monday, March 10, 2008
What is net current asset value (NCAV) and how can beginners apply it in stock market value investing?
Benjamin Graham, author of The Intelligent Investor, is credited with developing an investment strategy to find undervalued companies in the stock market by employing a measure called the Net Current Asset Value. Benjamin Graham was a big believer in buying stocks at a significant discount to their intrinsic value. His theory was that eventually the underlying value in the company would be reflected in the share price and in the worst case scenario, an investor would be protected from significant losses because the price of the stock shouldn't fall much further.
What Is Net Current Asset Value?
Put simply, net current asset value is the value of a company's current assets less all of it's liabilities. This means that you discard the value of any tangible non-current assets like plant and equipment as well as any intangible assets like goodwill. You only take into account current assets like cash (and cash equivalents), receivables and stock on hand. You then take away all liabilities - both current and non-current (this means things like long term debt, trade creditors and any provisions).
The idea is that this number (either on a per share or an aggregate basis) should be what a company is worth in the worth case scenario if the company is wound up. In the event of a company being wound up the value of assets like plant and equipment is normally greatly diminished and so is not taken into account in this calculation. In the other hand, all creditors will be lining up to claim what's owed to them, so all liabilities need to be considered at 100% of face value.
If you wanted to be even more conservative, you could discount the value of stock on hand as well, as the carrying value may not be realized in the case of a fire sale. You could discount it be 50% or even more.
The main concept to grasp with this stock investment strategy is that the net tangible asset value should be the absolute minimum amount that a company will be worth.
How Can Stock Market Investors Use Net Current Asset Value?
Benjamin Graham advocated a portfolio approach to value investing. He suggested buying a group of companies which exhibit favorable characteristics. In this way investors are further insulated from risk by minimizing the potential for a loss in any one company to cause significant pain to an investor.
Investors would buy and hold stocks in such a portfolio until either the value of any company was realized in it's share price, or the fundamentals of a company changed to such a degree that holding it was no longer deemed worthwhile.
How Can Investors Find These NCAV Bargains?
To my knowledge, there are no screens available to identify companies trading at a discount to their net current asset value. And it's not a figure that's published in any stock market data on any of the finance websites (Yahoo Finance and such).
Your best option is probably to find a short list of companies trading below their book value then work from there. Some sites allow you to display a selection of financial statistics and in addition apply a filter to the list. By selecting Current Assets, Current Liabilities, Non-Current Liabilities and Market Capitalization (or a similar set of statistics) then filtering on companies trading below book value, you should then be able to download the resulting data to a spreadsheet to complete your calculations.
However in my experience, patience is required. There have not been many companies trading at a discount to NCAV in recent times. I should say that in my search, I normally require a company to be profitable and also have a minimum market capitalization such that costs of liquidation wouldn't absorb all of the margin between the current price and the net current asset value.
Even if you don't find many prospects, you'll be surprised how much beginners can learn about stock market investing while doing this sort of in-depth analysis.
Monday, March 3, 2008
A beginner's guide to 'The Father Of Value Investing', one of the great stock market investing minds.
I thought I would write a series of articles about some of history's greatest stock market investing minds starting today with Benjamin Graham. Benjamin Graham was a professional investor, a successful author and is widely considered to be the father of value investing. And in a stint teaching at Columbia University 'The Dean Of Wall Street' taught some of great minds of the following generation of investors.
Graham first went to work on Wall Street for Newburger, Henderson & Loeb after graduating from Columbia at the age of 20. Then in 1926 he formed the Graham-Newman partnership with Jerome Newman. Graham is believed to have been personally ruined by the great stock market crash of 1929 and the Great Depression which followed. His partnership survived the crash and recovered to produce outstanding investment returns over an extended period. From what I recall, his average annual return was in the vicinity of 17%.
In 1934, along with co-author and fellow Columbia professor David Dodd, Benjamin Graham published Security Analysis. Security Analysis was an attempt by the authors to bring some structure and rigor to the field of stock market investing. After the carnage of the 1929 crash this was greatly needed.
Security Analysis is a hefty volume and I wouldn't recommend it to beginner investors, however it's well worth a read if you can set aside the time. Don't make it the first stock market investing book you read, but once you have the investing basics under control then you should definitely tackle Security Analysis.
The other perhaps better know volume to be penned by Graham was The Intelligent investor. I have already mentioned this book in Stock Market Investing Books For Beginners. The Intelligent Investor is one of the best stock market books I've ever read. As a beginner, the simple yet powerful concepts introduced in the book were both enlightening and inspiring. First published in 1949 and regularly updated until his death in 1976, this book has stood the test of time. Value investors the world over frequently quote Graham's text.
Benjamin Graham is responsible for the Mr Market metaphor. Mr Market wasn't a superhero, but rather a way for investors to think about the stock market. Graham said to consider your participation in the stock market to be like co-owning a profitable, stable business with a partner called Mr Market. Each day he will approach you with a price at which he would be willing to either buy out your share of the business, or sell you his. However, Mr Market is manic-depressive and the prices he offers fluctuate wildly as his mood changes. But the good news is he cames back day after day with a new offer and you are under no obligation to either buy from or sell to Mr Market on any given day. Your challenge is to not be distracted by Mr Market's erratic behavior and to take advantage of outstanding opportunities presented by Mr Market as they arise.
(Please note: My copy of The Intelligent Investor is out on loan, so the above description may not be true to Graham's original writing. However you should get the general idea.)
Another theme central to Benjamin Graham's teachings is the concept of a Margin Of Safety. What this means is that when you approach a particular investment opportunity, you should ensure you buy at a price sufficiently below what you think the value is that, should anything unforeseen happen you should still end up with a satisfactory result. In addition, he advocated diversification as a way of reducing the risk associated with any given investment.
Measures used by Graham to determine value include Price To Earnings Ratios, Dividend Yields and Net Tangible Assets. In addition Debt Levels and management attitude to shareholders should also be considered.
I'm running out of time and space in this post. There is much more the Benjamin Graham's teachings to what can be condensed into a single blog post. I suspect I will write another one at some point to fill in all of the gaps I have left in this post. I just wanted to finish up here by giving some indication of the caliber of students he taught while at Columbia.
Warren Buffett is possibly the most famous and arguably most outstanding of these. Buffett actually spent some time working with his teacher in the Graham-Newman partnership. He then went on to form his own investment partnership before eventually leading Berkshire Hathaway to almost unparalleled success.
Other student's of Graham's include Walter Schloss and William Ruane. Both very successful professional investors in their own right, William J. Ruane went on to manage the very successful Sequoia fund while Walter J. Schloss recorded a return of 16% over a half century of stock market investing.
I highly recommend Benjamin Graham's writings and teachings. Both beginners and the more experienced will learn a great deal about stock market investing from Benjamin Graham.
Tuesday, February 26, 2008
What are the best books about stock market investing for beginners?
In my recent article on stock market investing basics, I mentioned that stock market education was very important first step towards investing for beginners. In this article I want to take a look at some of the books I have found helpful in understanding investment principles and strategy. I've read a lot of investment books over the years and while they're all contributed to my knowledge to some degree, the following tomes are the ones that have stood out for me.
Having said that, I'm always on the lookout for new ideas so if you have any ideas - something you've read which stands out in your mind - then let me know. I would love to add a few more books onto my "to read" list.
The first investing book I'd like to discuss is The Intelligent Investor
Benjamin Graham is considered the father of value investing. He is credited with bringing discipline to the activity of security analysis. Before Graham, there was little structure in security analysis and through his writings and teachings he brought stock market investing into modern times. Although a successful investor in his own right, he is perhaps more famous for playing the part of mentor to a man who many consider to be the greatest investor of all time - Warren Buffett.
When I first read the Intelligent Investor, it was a revelation. Graham did such a great job of focusing your mind on what's important. He advocates stepping away from all of the noise in the stock market and instead concentrate on investment fundamentals. He concedes that over the short term, the market is a popularity contest. But over the long term, if you buy stocks at a significant discount to their intrinsic value, you should beat the market average.
What I like about Graham's writing is that he puts forward his ideas in a clear, concise and logical manner. He develops his arguments slowly but surely then counters any potential counter-arguments which may arise. He's also very strong in his research. He provides empirical evidence to support all of his main arguments. Although this book was first published over 50 years ago, I was astounded how relevant it is to today's market conditions. I highly recommend "The Intelligent Investor" by Benjamin Graham.
The next most influential investment book I have read is called Common Stocks and Uncommon Profits
Fisher thought the best results could be had by identifying the very best companies but studying the structure of the industry it operated in, management, commitment to research and so on. Price was less important as over time these companies would expand to many multiples of what you paid for them. What would it matter whether you paid $50 or $100 for a stock when in the future it will trade at the equivalent of $10,000 or more. Fisher's idea of having a small number of very high quality "growth stocks" was in contrast to Graham's theories of having a large number of heavily discounted stocks, but by reading both points of view, I think you will become a much better investor.
The last book I'm going to discuss in this article is One Up On Wall Street
One Up On Wall Street is a great read. It covers Lynch's first steps in the stock market, then takes you through his philosophy for choosing stocks. Lynch advocates sticking with what you know. He believes that we all comes across great investment opportunities everyday. We just need to keep our eyes open and be aware of the companies which operate around us in our daily lives. Lynch says that we have the opportunity the uncover these hidden gems and profit from them by buying in before the market at large becomes aware of the stock.
Lynch also categorizes the purchases he makes into one of 6 types. These are Slow Growers, Medium Growers, Fast Growers, Cyclical Stocks, Turnarounds - Special Situations and Hidden Assets. But I think what is more important than remembering the categories, is to understand why you are buying a stock. What do you expect from it? Do you expect to hold it for the long term? Will you hold it until some hidden value is realized. Or are you expecting a short-term reversal of fortune. I think this a very important concept. Understand why you are buying a company and know under what circumstance you would be willing to sell.
I decided to limit the list to only 3 books, partly because this article was long enough already, but also I didn't want to dilute the quality of the list. Don't get me wrong - there are a lot of other great investment books out there. Other books which just failed to make the cut include The Little Book That Beats The Market by Joel Greenblatt, The Warren Buffett Way by Robert G Hagstrom and The Money Masters by John Train.
There are also some great online resources which I'll cover in an upcoming article. But for now the above list should be more than enough information about investing in the stock market for beginners - and everyone else who hasn't read these books.
