Why invest in stocks?
Stocks allow you to own shares of successful companies such as Apple, Amazon, MasterCard, Toyota, Google, Exon mobile and others. It is much easier and less risky to own part of an already successful company vs. establishing a company. Also, stocks have been one of the best investments over time. For the past 90 years, the USA small and large stocks returned 12% and 10% a year respectively whereas Government bonds returned 5.5% and treasury bills returned 3.4%. Click Here
How do you make money owning stocks?
Through capital appreciation and dividends, you make money owning stocks. Capital appreciation is the profit of buying the stock and selling it later at a higher price. Dividends are the sum of money paid regularly by a company to its shareholders out of its profits. The total return of a stock is the sum of the capital appreciation and dividends. For example, if you bought an Apple share at 100$, sold it a year later at 150$ and you received an annual dividend of 2$, your total return is 52 $ (50$ appreciation and 2$ dividends or 52% total return).
Stock Market and Market indices:
The stock market refers to the collection of markets and exchanges where the issuing and trading of equities (stocks of publicly held companies), bonds and other sorts of securities take place. Stocks of larger companies are usually traded through exchanges, entities that bring together buyers and sellers in an organized manner where stocks are listed and traded (although today, most stock market trades are executed electronically, and even the stocks themselves are almost always held in electronic form, not as physical certificates). Such exchanges exist in major cities all over the world, including New York, London and Tokyo. Every company listed in the stock market has a ticker symbol which is a unique code used to identify its stock. The ticker symbol is usually shown in parentheses after the name of the company. Examples of the tickers are APPLE (AAPL), Master Card (MA), Priceline (PCLN) and Facebook (FB). A market index is an aggregate value produced by combining several stocks together and expressing their total values. Market indexes are intended to represent an entire stock market and thus track the market’s changes over time.
Examples of well-known global market indices are:
Global: MSCI World is a stock market index of 1,650 world stocks
USA: DJIA (30 large companies), S&P 500 (500 large companies), S&P 400 (400 medium companies), S&P 600 (600 small companies) and Nasdaq 100 (100 leading tech and biomedical companies)
UAE: ADI (37 most highly capitalized companies)
KSA: TASI (169 publicly traded companies)
Egypt: EGX 30 (30 most highly capitalized companies
The chart below, from investing.com, shows the progress of 6 market indices. In the past 7 years, USA S&P 500 return is 115.62% in the last 7 years vs. 64.63%, 12.54% and -65.74% returns of Abu Dhabi, Saudi and Egypt stock market respectively. It clearly demonstrates the power of investing globally as there are a better return and a lower risk due to diversification.
Understand how to evaluate stocks
Growth investing is an investment strategy that is focused on the growth of an investor’s capital. Those who follow the growth investing style – growth investors – typically invest in companies whose earnings are expected to grow at an above-average rate compared to its industry or the overall market.
Value investing is an investment strategy where stocks that trade for less than their intrinsic values are selected. Value investors actively seek stocks they believe the market has undervalued. Investors who use this strategy believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with a company’s long-term fundamentals, giving an opportunity to profit when the price is deflated.
Fundamental analysis is a toolbox to help you determine whether the company’s stock is a good stocks fundamentals investment. It looks to the company’s management, earning and sales growth, cash flow, profit margin and other parameters to determine its intrinsic value. Intrinsic value is the price a stock should sell under normal market conditions. The current stock price vs. the intrinsic value will reveal potential investment opportunities.
Technical analysis premise is that supply and demand drive all stock prices. It is an analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume. Technical analysis trader uses chart trends to forecast future price direction and places money to benefit from the price movement in that direction.
Important fundamental analysis measures are
Return on Equity (ROE): a ratio that provides investors with insight into how efficiently a company’s management team is managing the equity that shareholders have contributed to the company. Some people consider this the ultimate measure of a stock’s success. It shows the rate of return to shareholders by dividing net income by the total shareholders’ equity.
Cash Flow per share: Cash flow is a stream of cash from the business. The bigger the cash flow the stronger the financial strength of the firm. Sometimes even profitable businesses don’t have strong cash flows because they sell their goods on credit. Cash flow per share is calculated as Operating Cash Flow minus Preferred Dividends divided by Common Shares Outstanding.
Earnings per share (EPS): The ultimate growth measure and represents the portion of a company’s profit that is allocated to each outstanding share of a common stock, serving as an indicator of the company’s profitability. EPS is calculated as:EPS = net income ÷ average outstanding common shares
Price/Earnings (P/E): The king of Value measures and calculated by dividing the stock price by the Earnings per Share (EPS). In essence, the P/E ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings. This is why the P/E is sometimes referred to as the multiple because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. A low P/E can indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends.
Price per sales (P/S): A valuation ratio that compares a company’s stock price to its revenues. P/E compares price to earnings while P/S compares price to sales revenue. This is a very important measure as companies can manipulate earnings using flexible accounting rules but revenue is extremely difficult to change.
Quick Ratio: An indicator of a company’s short-term liquidity. It measures the dollar amount of liquid assets available for each dollar of current liabilities. Liquid assets are cash and equivalents, marketable securities and accounts receivable. A quick ratio of 1.5 means that the company has $1.50 of liquid assets to cover each $.
Dividend yield: A financial ratio that shows how much a company pays out in dividends each year relative to its share price.
Price/Earnings to Growth (PEG): A stock’s (P/E) ratio divided by the growth rate of its earnings for a specific period. The PEG ratio is used to determine a stock’s value while taking the company’s earnings growth into account, and provides a more complete picture than the P/E
Net profit margin: The ratio of net profits to revenues. High-profit margins are the hallmarks of companies that have superior products as they can dictate higher prices. It also tells you that the company’s management can control costs. Net margins vary from company to company, and certain ranges can be expected in certain industries, as similar business constraints exist in each distinct industry. Low-profit margins don’t necessarily equate to low profits. For example, Wal-Mart Stores Inc. has delivered high returns for its shareholders while operating on net margins less than 5% annually.
Stock buybacks:Refers to the repurchasing of stock shares by the company that issued them. Essentially, a buyback occurs when the issuing company pays shareholders the market value per share and re-absorbs that portion of its ownership that was previously distributed among public and private investors. Since companies raise equity capital through the sale of common and preferred shares, it may seem counter-intuitive that a business might choose to give that money back. However, there are numerous reasons why it may be beneficial to a business to repurchase its shares, including ownership consolidation, undervaluation, and boosting financial ratios.
Important Technical analysis measures are:
The investment strategies in this report use only fundamental analysis. Technical analysis is useful but needs much more time to use correctly and understand. It is out of the scope of this report. To increase your knowledge and skills of the technical analysis methodologies and measures, there are many books available at Amazon.com and some are for free when you have a Kindle unlimited membership.
How to search for stocks?
There are many ways to search for winning stocks. You can go directly to the investors’ section in any company website to find the annual reports and quarterly earnings release, or another great source of knowledge and investments leads are investment sites such as The Wall Street Journal, Investor’s Business Daily, Barron’s, The Street, Seeking Alpha, Yahoo Finance and ETF.com. I have memberships in Morning Star and Valueline.com. Some Stock brokers provide free stock screeners and researchers however, I prefer interactivebrokers.com which provides an excellent free analysis of both American and non-American stocks.
Different type of orders
This section explains bid, ask, spread and discusses different types of orders. The Bid is the highest quote price that buyers are willing to pay for the stock at this moment, while Ask is the lowest quoted price that sellers are willing to accept for the stock. The Spread is the difference between two numbers.
Market orders: An order to buy or sell an investment immediately at the best available current price. A market order is the default option and is likely to be executed because it does not contain restrictions on the price or the time frame in which the order can be executed. A market order is also sometimes referred to as an unrestricted order.
Limit Orders: An order to buy or sell an investment at a specified price or better, since a limit order is not a market order, it may not be executed if the price set by the investor cannot be met during the time in which the order is left open. Limit orders also allow an investor to limit the length of time an order can be outstanding before being canceled.
Stop Orders: An order to buy or sell a security when its price surpasses a point, thus ensuring a greater probability of achieving a predetermined entry or exit price, limiting the investor’s loss or locking of his or her profit. Once the price surpasses the predefined entry/exit point, the stop order becomes a market order. That means your broker will then trade the stock at its current price. If the price is moving quickly, it may be higher or lower than your stop price. This is an important difference between limit orders and stops orders.