3 Oct 2015

How to Invest in Stocks – A Complete Guide to Basics


What will you learn in this post:
. What are stocks
. Why invest in stocks
. Types of Analysis
. Which stock should you buy
. When should you sell a stock
. How much should I Invest
. How can you buy stocks
. Books to Read
. How to formulate your own investment strategy
. Learn the investment strategies of Great Investors
. Learn about various tools of investing
. Practicals (Homework)

What are stocks?
Stocks (or Shares or Equity) represents a part ownership in a company which entitles you to a part of that company’s earnings and assets.
Suppose you own 100 shares in a company ABC which has total 10,000 shares issued. Thus you end up owning 1% (100 shares which you own / 10000 total shares issued by ABC company). Thus suppose ABC company has Rs.100 crore profit, you are effectively earning Rs.1 crore of profits ‘through’ your investment in ABC company’s shares. If the same ABC company owns a building worth Rs.1000 crore, you are effectively owning Rs.10 crore of that building ‘through’ your investment in ABC company’s shares.
Common stock gives shareholders voting rights but no guarantee of dividend payments. Whether to pay dividends or to keep the profits with the company is decided by the company’s board of directors.
Before you buy your first stock, you should master the basics of stock investing. This won't make you a great investor overnight, but only when you understand the fundamentals of investing can you learn how to invest in stocks with confidence.

Why Invest in Stocks?
The reason is simply that over a long period of time, well chosen portfolio of stocks have provided the highest potential returns amongst all asset classes. And over the long term, no other type of investment tends to perform better.



The table below highlights some of the advantages and disadvantages of stocks vs some of the other asset classes:

Characteristic
Stocks
Bonds, Fixed Deposits
Gold
Property
Risk
Stocks are risky, they can decline their prices can fall over short periods of time.
Least risky of all asset class. Does not fall at all.
Risky, but price fluctuations are not much.
Risky, but price fluctuations are not much.
Type of asset
Paper (or financial asset)
Paper (or financial asset)
Physical (you get gold to keep)
Physical (you get property to stay or rent)
Returns
Highest
Lowest
Low, but slightly better than Bonds
Moderate.

One of the key risks of investments stocks or shares is volatility. This means that the value of stocks can rise or drop sharply in the short term. Sometimes stock prices may even fall for a fairly long period of time. Bad investments can easily dent your principal or capital.
You can be a winner in the stock market only by taking long-term investing approach and learning the basics of equity or stock investing. Of course, we think that by educating yourself and using the knowledge in this Equity Investing School, you can minimize the risk and maximize your expected return. We will help you with the right approach to invest and help you learn the tips and tricks to spot the winners. Again, this effort is well worth the time, because over the long haul, your money can work harder for you in equities than in just about any other investment.


Types of Analysis:
Fundamental vs. Technical
When it comes to stock analysis, there are two main schools of thought: Fundamental analysis and technical analysis. Fundamental analysis is all about using factual information about a company's business from its financial statements to try to find the real worth of a stock, while technical analysis uses gleaned from historical movements in market prices to predict the next stock's movement in stocks price.
Both the schools have very ardent followers. Both have produced excellent results for followers who have practiced either of these schools of thought. However according to us you can use the following to decide what works for you the best:
a) Fundamental analysis is useful for ‘investors’. These are people who want to remain invested in stocks for a long period of time. Their objective is to deploy large sums of their networth in stocks and earn returns better than inflation. EquitySchool focuses solely on this type of investing. You are in the right place if you belong to the long term camp.
b) Technical analysis is useful for ‘traders’. These are people who want to remain invested in stocks for a short period of time and want to benefit from short term fluctuations in stock prices. It can be useful for professional traders who make a living by continuously buying and selling different types of stocks. You may want to try some other educational websites to get more understanding and information on this type of investing as EquitySchool focuses solely on Fundamental Analysis.

Which stock should you buy?
This is actually a billion dollar question. You need to sift through hundreds of stocks, use tools on this website or across the web to find ideas to invest. Once you have zeroed in on potential candidates, you need to perform detailed fundamental analysis to judge the worth of the company, how much is its potential growth and whether it can be the right investment for you. This is a journey in itself which requires patience, dedication, hard work, intense application of knowledge, judgment and above all a keen interest in the journey rather than the goal.
Keep reading articles on EquitySchool to learn how to generate ideas for investment.

When should you sell a stock?
Ideally should sell a stock when
a) the reason why you have brought the stock changes, or
b) the stock price has appreciated more than it is worth or
c) you have found a better investment opportunity.

The concept is simple: Let your winnings run, and cut your losses early.
The best thing to do is not to watch the stock prices, but the company's fundamentals. If the fundamentals deteriorate that should be a red flag for you to exit.
If you think the stock price is behaving in a euphoric manner, you should consider selling if is trading significantly above what you think is its fair value.
You may also consider exiting or selling a portion of your investments, if you find some other stock which is offering a better investment potential than the one you are selling.
According to a legendary advice from the world's most famous investor, Warren Buffett - "You should be greedy when others are fearful and fearful when others are greedy."

Please remember that these are absolutely basics. You need to read more to master the art of investing and winning. Reading basics will not give you success. It only shows you the right path.

How much should I Invest
You should always start with a very small investment in the markets and then gradually build it over time. Learn from your investments, as markets are a great teacher. Incurring losses on small sums of money will not damage you financially, but will serve great lessons when you invest a larger capital into the market.
Also, the amount available for investment should depend on liquidity requirement for next 5 years. Do not invest any money which you may need for the next 5 years. Also, do not invest any money in stock markets if you are dependent on monthly interest income as your source of earnings to meet your daily bills for food, clothing or shelter.

How can you buy stocks
You can buy stocks only through registered stock brokers. A simple search on the internet with the term “stock broker” along with your place of residence will give you enough choice to choose from amongst the leading brokers. Do your own due diligence before opening an account as the relationship you’re your broker can be pretty long term.
Usually there are two types of brokers - Full-service and Discount
a) Full-service brokers:
These brokers tend to offer a complete bouquet of financial services including investment advice and research. They may offer brokerage services in other asset classes like stocks, bonds, derivatives, annuities, and insurance. The only downside of these type of brokerages is that they charge considerably higher fees. Usually Full-service brokers are best option for a newbie investor

b) Discount brokers:
Discount brokerages offer no advice or research - they simply offer transaction services for your trades. These brokers are often “Online’ only and there may not provide any human assistance.

Books to Read
Investing is an art and science. You need to be a ‘learning machine’ to master the investment process. Following are a list of just three books to get you started:
. The Intelligent Investor
. The Warren Buffett Way
. One Up on Wall Street

How to formulate your own investment strategy
Time to formulate your very own amateur ‘investment strategy’.
Ask yourself - Are you an investor or a trader?
Many investors use a consistent, long-term strategy to build a more secure financial future through steady purchases of well-researched stocks.
Traders and market timers are usually less concerned about consistency (refer the discussion on ‘Technical analysis’ above). Most people would probably say they are investors, but the question is not so easily answered. During a bull market, it can be relatively easy to be a long-term investor. However, when the stock market starts gyrating, investors' mettle can be tested—revealing many closet speculators.
Once you are clear write down on a price of paper the following questions along with your answers:
a) What is my investment time horizon – (you should not enter equity markets if time horizon is lesser than 5 years)
b) What is more important to me- medium risk medium return or high risk high return (If you prefer medium risk medium return stocks then stick to tried and test large capitalization companies, and if you prefer high risk high return stocks then generate ideas in promising smaller capitalization companies)

Use the above ‘Investment Strategy’ whenever you are doing research on new stock ideas for investment. It should introduce discipline in your investment process, which you should keep refining and updating as you learn more about investing.


Learn the investment strategies of Great Investors
Use Equityschool.in helpful articles on Great Investors investment strategy or tools used by them to identify and nourish promising investments
.
Learn about various tools of investing
Use Equityschool.in helpful articles in ‘How To’, ‘Theory’ or ‘FAQ’ sections to keep honing your investing skills.

Practical Time (Homework):
Enough of theory! Let’s now start practicing some of the things we have just learnt. Following activities should help you start with your fundamentals analysis:
a) Track five stocks for three months. Pick three stocks you like instinctively and two you don't. Take a look at the fundamentals of each, and try to make an objective decision about each stock based on those fundamentals alone. Keep a record of how each pick progresses from selection to the three-month mark. You can use Moneycontrol.com portfolio tracker for this activity.

b) Cheat Sheet. Build a Cheat Sheet by noting down your thoughts for each company you are tracking over this three month period in this sheet.

c) Build your benchmarks. In your cheat sheet, also include one another company in the same industry to use as a benchmark. Over a period of time, this will help you understand the importance of industries and relative analysis. 


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