STOCKS 101: Part 2
By: Serena Patel
Continued from STOCKS 101: Part 1 - please read before this next part!
Okay, I’m going to start right where we left off.
Don’t spread yourself too thin.
If you are starting off by only investing a small amount in individual stocks, don’t spread yourself too thin. While it is good to diversify later, you generally see a larger return when you have substantial shares.
I made this mistake when first starting out and bought several different stocks. It’s easier to start with one because you’re not only investing money, you’re investing time. You have to be able to keep up with the stock, market, current events and trends. It is hard to keep up with everything all at once when you have too many stocks to follow, along with a day job, hobbies, life, etc.
Scenario 1: You buy 3 shares of Stock A priced at $10.00. You buy 2 shares of Stock B priced at $15.00. You buy 1 share of Stock C priced at $40.00. You spend a total of $100.00.
A year later when you decide to sell, Stock A is now priced at $15.00, Stock B at $13.00 and Stock C at $35.00. Overall, you gain $6.00 in profit.
Scenario 2: You buy 10 shares of Stock A priced at $10.00. You spend a total of $100.00. A year later when you decide to sell, Stock A is now priced at $15.00. Overall you gain $50.00 in profit.
Scenario 3: You buy 10 shares of Stock A priced at $10.00. You spend a total of $100.00. A year later when you decide to sell, Stock A is now priced at $8.00. Overall you lose $20.00.
In Scenario 1, you spread yourself too thin. You gained a small profit because the gains and losses on each stock evened out. In Scenario 2, that is your ideal situation. You do research on a stock you are sure will increase over time. Your research is accurate, you are lucky, and the market is working in your favor and you gain a large amount. In Scenario 3, since you were taking a risk by putting all of your eggs in one basket, and the market can be unpredictable and change frequently, you, unfortunately, lost money.
While investing in one stock can result in a larger return, it can also result in a larger loss. This is a risk you have to determine if you’re willing to take. Like I’ve said before, start off investing an amount you’re comfortable losing when starting off with individual stocks.
How do I choose what stock to invest in?
Conduct thorough research, evaluate your options and stay up to date with the market and current events. Also:
What is your investment strategy?
Do you want to play it safe? Are you okay with low, but slow and steady returns? Are you willing to be risky? Do you want to make a quick buck?
What you choose ultimately depends on what your overall goal is. For beginners, I would recommend staying on the low to medium risk side, as you may not know when to sell or may not have the time or knowledge yet to keep up with the market or your investments actively.
Understand the Market
Every company is continuously impacted by what is happening everywhere. To keep up with the market, you have to be aware of what is happening with the world, companies you’re considering, policies or regulations within that country, trends in society, technology, etc.
Are you considering investing in vehicle manufacturer General Motors? Have you noticed more people buying cars lately? Have you heard that they have been testing self-driving cars that will be available by 2019? It seems like the price should go up in the future. But wait - what about the steel and aluminum tariff Trump just imposed on imports from some countries? If their materials cost more, the price of their products will increase too. Will people buy less? Will this drive business down? Do your research. Understand what is happening in the world. Even news that doesn’t immediately seem like it would impact the market will in some way.
The Past vs. The Future
Just because a pharmaceutical company has done historically well, what if a new trial doesn’t return the results the company and investors hoped for? How big is this set back? If big enough, it could cause a downward spiral.
For the big five tech stocks: Amazon, Facebook, Microsoft, Google, and Apple - how do they play a role in everyday life and society? The advancement in technology doesn’t appear to be slowing down and these companies are on top of it. They have been doing historically well and it appears they will continue to do well. Think about it, businesses like Toys R Us, Babies R Us, even Sam’s Club locations are being closed down because people can and do order everything straight from Amazon. It’s convenient and sometimes cheaper. Think about the companies you interact with daily.
What are some companies you are starting to hear about or use a little bit more recently that you see some potential or promise in? I see Square being used all the time now - restaurants, food trucks, small businesses, etc. Do you know what it is? Have you ever had to swipe your credit card through a phone or tablet and sign/tip on the screen? That is usually Square. Do you see it stopping? It’s easier and cheaper for smaller businesses to process their credit card transactions. I see potential in it. On January 2, 2018, Square was priced at $36.17 per share. Today (July 10, 2018), Square is priced at $66.48. Can you imagine if you bought 10 shares in January and sold it today? You would have made $303.10 in profit. It has nearly doubled in 6 months.
Also, research companies or industries that cannot be easily replaced such as Walmart, Johnson & Johnson, and ones you wouldn’t normally think of like Waste Management, American Water Works, etc. Think about things in your life that have always been there and will always be there - who produces those items? Who are their suppliers? Find the profitable source, these could be good long-term buys.
You have to be aware, conscious and insightful. Understand what’s happening in the world around you, what’s changing, and what the future holds.
After you choose an industry and you’re looking to narrow it down between a few options, here are some basics to look for:
Simple. Is the revenue increasing by quarter? If not, why are you considering it? If it is, is profit also increasing? If profit is not increasing, why is it not? Have expenses increased? Has the company taken on a new project that is a currently causing profit to decrease (because it is a current expense that is not yet generating revenue)? Do you see the potential in that new project when implemented to exponentially increase revenue and cause an increase in profit?
Sometimes companies will pay a portion of its net profits to its shareholder.
If you own 10 shares of Company A and Company A decided to issue a $0.43 dividend, you receive $4.30. The dividend is paid out per share.
Companies can choose whether or not they want to pay out dividends, at what rate and how often (if at all). Companies that pay out dividends can indicate a favorable future as they’re currently doing well enough to pay their shareholders.
Sometimes a company who is still doing well may choose to not pay out dividends and instead reinvest their earnings into growing and further developing the business. This could indicate a potential future return depending on their direction. This could also be good as they are using their own earnings instead of increasing their debt to further expand.
But at the end of the day, dividends are good, and no dividends are not always bad.
Know When to Sell
It is just as important to know when to sell as it is to know when to buy a stock.
I don’t recommend buying or selling your stocks daily, weekly or even monthly for a quick buck because you’ll be taxed on your profits (no matter how small). If you hold your stocks for less than 1 year, you will be taxed at your current tax rate which is about 25-30%. If you hold your stock for a year or longer, you will be taxed at the capital gains rate which is 15%. That is substantial.
As a beginner, hold unless you are certain that you will lose more than you will gain/lose right now and if that difference covers the extra tax you will pay for selling.
If you have a stock that did well and is starting to fall, and you don’t see an end to the downward spiral - cut your losses and sell. If the share price has continuously decreased since you’ve bought it and you never saw it rise and you now have no faith it will - cut your losses. If the share price has increased, but something happened in the market and you think it’s going to go down significantly, you can sell. Just do your research below and really evaluate if it has future potential.
If your stock is doing well, say the price has doubled, but you’re a bit of a safer investor and you don’t want to risk the price dropping in the future, then you can sell half. If you sell half, you cover your initial cost. Whatever happens to the remaining half - whether the price continues to increase or drops, it will still be a profit when you sell.
If your stock is doing well (higher than what you originally bought it for), but you predict it may drop in the future to an amount lower than your original cost, but will rise again after - you could sell high (for profit) and then buy more when its low (when the price drops), hold onto it until it increases again and sell high again (for a profit). There are always fluctuations in the share price. It is ideal to buy low when the stock is undervalued and sell high at what you think it is actually worth.
No platform, website, analyst or person can tell you “sell now,” or “buy later,” and be certain of that decision. It’s one you have to make and risk. It’s actually one of the most uncertain aspects of stocks overall because it is so hard to predict what will happen in the future and what can change.
Again, I know that was a lot of information for our beginners, so please email us or comment below if you have any questions or want further clarification. Also, we’d love to hear what other finance, accounting, or investment topics you’d like to learn about!