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, May 26, 2008
Is dollar cost averaging a suitable stock market investing strategy for beginners?
In this article I will describe what dollar cost averaging is and how beginner investors can put it to good use. From my recollection, Benjamin Graham (the father of value investing) proposed that the use of "formulas" like this was a good way to protect investors from themselves by reducing the risk of investors trying to time the market.
What Is Dollar Cost Averaging?
As I've already said, dollar cost averaging is a stock market investment strategy (or a form of formula investing). The basic idea is that an investor buys stocks at regular intervals thereby 'averaging' their purchase price. The advantage of this method is that investors avoid putting all of their their money into the stock market right at the top or just before a fall. By buying stocks in smaller amounts on a regular basis, you will be buying right through the stock market cycle - both the ups and downs.
Is Dollar Cost Averaging For You?
I have to admit to being a little cynical when it comes to dollar cost averaging. Sometimes it seems to be more of a marketing gimmick employed by mutual funds and other purveyors of investment products. They seem to use it to promote products whereby you buy shares or units in their mutual fund on a monthly basis. And you can understand why - they put a lot of effort into convincing you to part with your money, so rather than getting you to buy once they get you onto a regular plan. They will even take the money out of your pay to make it easier.
However, I think there are some scenarios where dollar cost averaging may be worthy of consideration.
I think the principle of regular investment is sound. It can help prevent a new investor putting all of their money in at the top of the market. Also, in uncertain and volatile times (such as we're experiencing at the moment) it can help prevent investor procrastination. By that I mean an investor who sits on his (or her) hands waiting for the market to bottom out only to wait too long and miss the start of the recovery. Or they might try to pick the bottom and invest once they see a recovery under way, only to find the recovery short lived and the subsequent downturn takes the market to new lows.
In this situation, a regular investment program can help the investor psychologically. By committing a portion of their capital this month, then another portion the following month, they can cover both cases. If the market does recover, they can take solace in the fact that they bought in at lower prices. And if the market continues its downward trend they still have the funds available to make purchases at lower levels.
Another potential positive of dollar cost averaging as a stock market investing strategy is in its use as a regular savings plan. In my opinion a regular savings plan is a great idea regardless of what shape or form it takes. If by drip feed investing a portion of your pay or salary into a financial market you are able to accumulate and growth your wealth then I'm all for it.
In the past, I've used a form of dollar cost averaging at times of market uncertainty - including the most recent downturn. Rather than trying to indulge in market timing by picking the bottom of the market, I would buy the stock which provided the greatest value at the time I was buying. With financial markets plummeting, I was concerned about the risk of investing all of my money only to see the market drop by another 10% or more. Regardless of how objective I try to be, the idea of purchasing stock, even for the long term, only to see it keep falling is an unpleasant one. But by keeping funds in reserve, I'm able to purchase that or other stocks at the lower prices. Please note that this is where I'm confident of the long term prospects of the company in which I'm buying stock.
So, as you can see that even though I have my concerns about dollar cost averaging, there are times when it may be useful. But as with the application of any stock market strategy, it should revolve around the purchase of quality stocks.
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.
