So you’re interested in buying some stocks, and I’m happy to help. Whether you’re buying stocks low and then selling them high for quick profits, or you’re in it for the long run – a strategy loosely known as “buy and hold” – you’re bound to feel the burn of a stock price drop at some point. Stock prices move up and down every day, and you cannot control or manipulate them to your advantage. Price fluctuations and exposure to loss is certainly not exclusive to first-time investors or the inexperienced – top money managers lose cash with bad investments and downward price movements too. In fact, the only man in the history of finance to ever not lose client money in stocks and other financial products: Bernard Madoff, because he wasn’t actually investing it – he was simply stealing it (click here for more info on ponzi schemes and hot to avoid them).
So you’ll just need to accept the fact that you won’t always be right. But if you take the time to study, understand, and respect stock markets and their powerful abilities to give and take money, you’ll do just fine in the long run. The goal is not to be right every time – just be right more often than not. And the likelihood that you will achieve success in the stock market over the next 30-40 years (or however long you have until retirement) is almost guaranteed. You only need to look at the history of stock markets: consider that, at one point, theDow Jones Industrial Average was worth only 1 point. Today, the DOW sits at 10,200 points.
Here’s a few lesson you should follow as a first-time investor when you have a company in mind that you want to buy, but aren’t sure if you should. After all, no one wants to lose money.
First lesson: know your company. This is a simple concept that is not always followed by first-time investors. A lot of investors and traders (people who buy and sell stocks everyday for a living) use strategies that do not consider “knowing your company” to be very important. But if you’re considering buying a company, consider this: wouldn’t it be easier to understand what’s going on in a company’s market, their industry, or with their competitors than one you don’t know? Here’s an example. You’ve heard Microsoft is a great stock to buy, but you don’t know anything about technology or software. You know nothing of the company, who they are, or what they do – much less about Oracle Corp. or Apple Inc, their major competitors. You see their stock price – $28 a share – but you don’t know if that overprices, underpriced, or the right price. But you do know about retailing because you’re a manager in a clothing store. Maybe you already own stock in the company you work for because it was given to you, which is great. But it is the best retail stock to own? There are 5000 other retail industry company stocks in the markets to choose from – where do you start? Knowing your company is important in the event that the stock price plummet’s because you’ll know if it’s worth holding or not. Consider that during the market crash of 2008, companies lost 40-80% of their stock value, and I mean almost ALL companies. Maybe financial stocks we’re deserving of their devaluation, but what about movie theatre stocks? Movie theatre stocks posted enormous profits because as investors saw last year, in a recession, people don’t stop going to see movies. It’s all about valuation.
Second lesson: put a value on your company. Attaching a value to the company whose stock you’re thinking of buying isn’t easy, and there isn’t one way of doing it. In fact, there are hundreds of different ratios, facts, figures, statistics, quarterly and annual financial reports and accounting practices that creditors and professional investors use to get very specific in their valuations. But as a first-time investor, you needn’t any of that confusion – keep it simple.
(The following valuations can be found easily on yahoofinance.com – keep an eye out for a video I’ll post that will accompany this post showing you how to find these figures for any company you’re considering buying).
For all these valuations, you’ll need to determine whether they are in an uptrend, a downtrend, or neutral. Click on the link to see an example of a company who demonstrates desirable uptrends/downtrends for each value.
Income – Find out how much income your company is pulling in. Find out what the revenues are (money before expenses). And while you’re at it, consider their expenses too. It’s found on the income statement of any company, and you’ll want to see an uptrend in revenues and a downtrend or neutrality of expenses.
Debt- Is your company swimming in debt? Forget the stock. Long-term debt is essential to a company’s growth, as long as assets outweigh the debt. Short-term debt, however, pilling up way beyond assets could be a red flag, especially if it’s been getting worse over the last few quarters. Look for an uptrend in assets, a downtrend in debt, or neutrality in debt.
Earnings – look for an uptrend in earnings over the last few quarters and the last few years. Neutrality is OK, but don’t necessarily expect a jump in the stock price based on shareholder equity (earnings) if the company isn’t growing in that regard.
That’s a solid start in determining the value of the company you’re thinking of buying. But it doesn’t stop there – even if your company has satisfied all these conditions, there’s still much more to consider. Contact us for more information on how to value a company beyond these three simple figures.
Third lesson: don’t panic! You’ve done your homework. You’ve followed our recommendations every step of the way (or maybe you didn’t and still ended up with a great companies stock). Congratulations! But the stock price just dropped, and so did your stomach. You’ve watched your stock lose 5, 10, or maybe even 20% of what you paid for over the course of 5 days. Your mind is racing and your heart is pounding; when will it end? Could it drop more?
Again (unfortunately) there is no single answer. But here’s a start: don’t panic. Not all stock drops are deserved! Remember, stock prices drop because investors who hold the stock are selling them in large volumes. Sometimes, a stock can get “oversold” on hype or news. But here’s an important point: know how valued your company is – not just by your expectations, but by the market’s expectations, too. Will the stock price come back up? In the long-run, certainly (with a few historical exceptions such as the fall of GM due to overwhelming debt and a gradual loss of American car-maker market share, or the fall of Lehman Brothers due to extreme financial risk-taking). You’ll find yourself asking, “But what about now? Will the stock price come back or should I sell and cut my losses”? In most cases, cutting your losses is a bad idea. Once you actually sell your stock, the loss is permanent – as opposed to just holding a losing stock, which could come back eventually. Consider the 6-month stock market free-fall between September 2008 and March of 2009. Investors who sold their stocks after 5 long painful months of seemingly never-ending losses at the market’s bottom in March 2009 made their losses permanent. But March 2009 to November 2009 saw the world’s largest and most aggressive bull rally – stocks as an average gained between 40-50% in less than a year! In fact, a quick look at a chart of the DOW reveals a few interesting things – including the fact that if you got into the stock market in 2000 and stayed until today, you would have actually just went up, down, up, down, and then even. You would have lost only -1% over ten years!