How To Tell Which Are The Best Shares To Buy
So you’ve heard about people making a mint from the stock market, and you think you’re finally ready to dabble in it too. But where do you even start? If you were anything like me, that’s as far as you’d get before becoming overwhelmed.
“How do people know what to buy?” I’d think in wonder before giving up.
This year I vowed to finally find out how to figure out what shares to buy, so I turned to John Likos from Morningstar Australasia – a leading provider of independent investment research. Here’s what he shared.
First things first – what exactly is a stock or share? They’re shares or equities issued by companies to provide funding for a wide range of purposes. Essentially, companies issue a “share” of the company to raise capital. In return, the buyer’s share could increase (or decrease) in value, and they may be paid dividends, or a share of the company’s profits. In Australia, they’re traded on the Australian Securities Exchange (ASX).
Buy what you know
Buying shares is investing in a company, ideally one that you predict will do well. If you know the nature of the industry and the company’s competitors well, you’ll have a better chance of forecasting what the share price will do. When finding shares to buy, the best place to start is with what you know.
“Is the company profitable? Do they have a lot of debt? What are the trends in recent years?” are all important questions.
If you buy shares from a company you don’t know, however, you might wind up buying a high-risk stock and chance losing your entire investment.
“By undertaking your own research, you reduce the risk of [investing in companies you] don’t know as you become more familiar with the company and its associated risks,” says Likos.
How to evaluate a company’s financial health
In today’s day and age, there’s no shortage of information available to help with investment decisions. The tricky part is deciphering which of that is objectively independent and which isn’t.
When evaluating a company’s financial health, start by reading the management discussion and analysis in the company’s annual report as well as the balance sheet, profit and loss and cash flow statement.
“Is the company profitable? Do they have a lot of debt? What are the trends in recent years?” are all questions it’s important to have answered, says Likos.
All companies should also have a helpful “Investor Relations” link on their website.
“That’s an excellent starting point, especially the company presentations within that. These could be analyst briefings or irregular presentations.”
He also suggests listening to Analyst Q&A sessions at the end of earnings calls. There are also sources for independent analysis, such as Morningstar itself, or even the financial or business sections of newspapers.
How to assess future industry trends
Industry dynamics are a critical determinant of a company’s value. For example, the more competitive the industry, the more challenging it is for the companies within that industry to display higher profit margins.
Supermarket chains, for example, are in stiff competition and, as a result, some have seen their profit margins fall.
Again, a good way to assess industry trends is to read the management discussion in Annual Reports as well as other company information in the Investor Relations links on the company websites.
“Do this across the company you’re analysing as well as its key competitors,” Likos advises.
Terms to know
While you’ll come across a laundry list of terms you’ve never heard in the process of investing, intrinsic value, fundamental analysis, and value investing are three important ones to know.
“It’s possible to lose all your investment if the company you invest in goes bankrupt.”
“Intrinsic value” is the actual value of a company based on underlying perception of its true value. It may or may not be the same as the current market value. To evaluate a stock’s intrinsic value, you use the process of “fundamental analysis”, which includes examining a stock’s value in terms of a range of factors including overall economy, industry, financial and management conditions. “Value investing” refers to a strategy where stocks are selected that trade for less than their intrinsic value.
Know the risk involved
If you’ve heard of people making a mint from the stock market, it’s likely you’ve heard of the opposite happening too. Stock price performance can be very volatile. High-risk companies tend to be the most volatile, whereas low-risk companies tend to be the least volatile.
“It’s possible to lose all your investment if the company you invest in goes bankrupt, so you must undertake thorough due diligence when selecting which stocks to buy,” says Likos.
It’s also important to seek out advice from qualified professionals if you’re not sure where to start. If you decide to trade shares through your bank, they will usually offer something like a managed fund, where professionals monitor your investment and trade on your behalf intending to make a profit.
Where to seek advice
Newspapers, magazines and relevant television shows are a great place to start. There are also many publications, which provide great investment advice and lessons. One example is the Intelligent Investor, written by Benjamin Graham. Although it was first published in 1949, it remains a timeless classic that many continue to rate as the stock market bible.
“[Other investors] are also an excellent source of information. This could be individuals working financial markets or even in the industries of companies you’re looking to invest in,” says Likos.
A mentor is another excellent idea for those looking to begin a path of investing. Research is key to starting out in shares – the more you’re informed, the better decisions you can make.
Sangeeta is a Sydney-based writer originally from Washington, D.C. She enjoys spending full days at the beach, browsing plant shops, and eating macaroni and cheese. You can check out her enthusiasm for clichéd sunset photos on her Instagram @sangeetatatiana.