Meet Bright, the “intrepid” investor
Bright thought it was time to get into the stock market business and decided to open an account with a stockbroker. He quickly asked for a list of stocks that he could buy and then sell for “huge” profits as quickly as possible.
The following six months were like a roller coaster ride as he entered and exited stocks at will and without fear. How in this world had he missed this “business”? After all, all he needed to do was to buy a stock and then sell as soon as the price appreciated to his sell target. He hardly knew the companies he was buying, or what they even did to make money.
Many get into the stock market with this sort of mindset. While many make money this way, they oftentimes fail and when they do, they do so, woefully. The stock market is erroneously seen by many as a place to stake bets without understanding the underlying principles behind how it works.
Types of investment principles & investors
Just like in other businesses, investing in the stock market requires that you understand which principles work best for you, and stick to them.
Growth and Value Investors are perhaps the two most popular types of investors in the world, along with their respective principles.
Growth Investor: Growth investors are predominantly interested in high growth companies. They believe companies that have the potentials to grow very fast present the best opportunities for them to increase their returns on investments.
Most growth investors rely on technical analysis, basically the study of share behaviour with the aim of anticipating future movements. They rely on charts and other aspects of share activity to predict how share prices would swing.
They, therefore, lay a lot of emphasis on seeking out stocks with potentials to increase their share prices within the shortest possible time. Growth stocks also have very high P.E ratios of 25x and above, as the market places a very high premium on their share prices.
Growth stocks also report high revenue growth, even if they are not commensurate with profits. They grow their revenues by over 100% annually and sell products or services that are eye-catching and fairly new in the market.
Value Investor: Value investors seek out stocks with high intrinsic values, often higher than the market prices that they are sold for. They like to buy stocks that are perceived to be undervalued, believing that very soon, the market would recognize their true values and then price the stocks accordingly.
They can be very patient and unlike the growth investors, prefer stocks with lower P.E ratios (often single digits). In seeking out these value stocks, they rely on fundamental analysis, a method that relies on the financial statement of a company, its management, competitive advantage and ability to outsell its competitors in deciding whether to buy shares in a company. This is a painstaking technique and requires countless man-hours, poring through financial statements and researching the company behind a stock.
Which is better?
There have been different researches as to which investing method provides the best investment results over the years. Some even utilize a hybrid of the two with very impressive results.
Choosing between the two depends on your strengths and ability to make the right decisions by relying on either or both.
What shouldn’t you do?
Speculation: What you should thus avoid is buying shares like you are gambling. Even people who rely on technical analyses spend a lot of time analyzing trends and movements in stocks to determine when they buy, sell, or hold. You should therefore not buy shares in a company because everyone else is buying (herd mentality) or simply because someone recommended it to you.
Many who speculate in share investment claim that it is very profitable, however, what they probably won’t tell you is that it is also the fastest way to lose money. You can lose all that you have made during a year-long’s bullish spree in a matter of days.
Margin Lending: This is basically borrowing money from the bank to invest in shares which should also be discouraged if you do not dedicate at least 90% of your business time in investing in shares. It is a sure way of getting bankrupt.
When you invest in shares, you have basically taken a decision to buy a part of a company. Even when a friend offers his car for sale, apart from negotiating a price, you go ahead to test drive the car and ask your mechanic to check its condition. If you can take that much time in deciding whether to buy a car or not, then why not do same for shares?
You must understand the company you are investing in and what it does. Find out who members of the management team are and review their competencies. Ask yourself if what they sell is something you will like to buy.
Back to Bright…
Bright ended up losing nearly all his investments in the ensuing stock market crash of 2009, as he knew little of most of the companies that he had bought shares in. Stocks he bought at N2 per share have remained at the rock bottom price of 50 kobo per share, years after.
This article first appeared on Nairametrics on March 24, 2014.