Stock Investing – A guide form A to Z
Psst! Have you ever felt like there are just so many things to consider when trying to decide which stocks you should invest in?
And has that feeling ever given you “decision paralysis” where you decide it’s better to just do nothing? Or maybe you’ve been brave enough to make an investment decision but still have that uncomfortable feeling of not being as confident as you’d like to be in the decision you’ve just made.
Don’t worry if you’ve ever been in this position – we’ve been there too, and we want to share a framework with you which we hope will give you the knowledge – and consequently, confidence – you need to make awesome investment decisions 💪
We like to approach investing using the following 5 “buckets of thought” which you can use as a way to feel comfortable that you are covering all the necessary ground when it comes to investing: Equity Story, Financials, Capital Markets, Trading Characteristics & the Broader Financial Market Context.
Let’s take a closer look at what kinds of topics each of these 5 buckets actually involves:
1. Company activity: This involves looking at what the company has been doing in the recent past, what it is doing now, and what they say they will do or what you expect them to do in future. It also involves having a sense for how the company is viewed by its stakeholders: customers, employees, partners, suppliers and shareholders. If you think through all of these, you’ll get a good idea of whether this is a high-quality business or whether it has some room for improvement.
2. Competitive landscape: This involves identifying the most relevant competitors and looking at what they are doing. Are they better or worse than the company you’re thinking about investing in? And is this difference in quality and competitive positioning reflected in the difference between the two companies’ valuations?
3. External factors: Is the company you’re looking at facing headwinds or tailwinds from the external world? This could include things such as potential legal issues the company is facing, or perhaps a shift in consumer attitudes towards the company or its industry which could be helping it grow. Taking these factors into consideration could give you a specific reason for investing, or staying on the sidelines for the time being.
1. Track record + current state of play: Here, you should consider the overall financial health of a company you are considering investing in – has it been solid in recent months / years, or has it been facing difficulties? In either case, having a good understanding of where the company stands right now will help you to make a better judgement about where it is likely to go in future, helping you to make an informed investment decision.
2. Expectations: Taking into account what the market expects from the company is vital, as that is likely what will determine the company’s share price today. What do research analysts expect the company to do in the future? Having a sense of what research analysts and other investors in the market expect from a company can help you to decide whether you think these expectations are either over- or under-optimistic and consequently inform your decision to sell or buy the company’s stock respectively. This is probably one of the most important factors to consider: making good investment decisions is fundamentally a function of the difference between expectations (your own vs. the market) and the reality that eventually plays out.
3. Multiples: What is the relevant financial metric for the stock you are looking at and the broader industry too? P/E is a popular financial metric for a lot of industries, but in some cases it can be more appropriate to look at things such as Price/Sales (helpful when the company is experiencing strong revenue growth but is not profitable) or EV/EBITDA (helpful when a company has significant debt but is an established, profitable business). It helps to be able to identify the appropriate multiple for the industry you’re looking at and then use that to compare the difference between your potential investment and its closest peers to really give you a sense of whether the market thinks it is a lower or higher quality business than the competition.
1. Capital structure: What is the total enterprise value of the company (equity value + net debt)? How much debt does the company have relative to equity? And how much debt does the company have relative to its ability to service that debt? An industry favourite is looking at net debt / EBITDA as a guide for whether the company is able to produce the cash flow needed to avoid any financial difficulties. Most publicly traded companies have a net debt / EBITDA level of anywhere between 0 – 4x. Anything higher than this should give you a reason to stop and think through why the company is carrying so much debt!
2. Capital market activity: Has the company been active in the capital markets? To get a better sense for this, you should look at when and how much equity and/or debt the company has issued in the last few years. A company which frequently issues new equity might reduce your overall investment returns due to dilution. On the other hand, a company which has been reducing its equity by engaging in share buyback programmes or otherwise could help boost your returns. Similarly for debt, if the company has been borrowing a lot in recent times, you should ask yourself why that is, and whether the borrowing makes sense for the company on the whole. And on the flip side if the company has been reducing its debt load, you should think about what this might mean for the company going forward.
3. Debt ratings: Each company which issues publicly traded debt has a credit rating – similar to your own credit rating, where a ratings agency rates the company’s debt on a scale to help you understand how likely it might be to go bankrupt. This is worth double checking too before investing so you know you’re not investing in a company that is likely to default on its debt anytime soon.
1. Liquidity: You might find a great stock to invest in which checks out with all the other things we’ve covered on the checklist here, but if the stock is illiquid (i.e. doesn’t trade very much) then it might be a good reason to hold off on buying those shares. If your investment decision is likely to move the share price then the stock is presumably highly illiquid, and if things go south with the investment you want to make sure you are able to exit your investment and protect your capital without further impacting the share price. For most of us retail investors this shouldn’t be an issue (unless you are investing tens of millions in a stock!), but something to consider. A very quick and basic way to “tick this box” is just by looking at the share price graph – is it full of small ups and downs with a lot of movement (look at the Apple share graph for example) or is it quite jittery with lots of sideways movement and the occasional sizeable upwards or downwards move?
2. Volatility: How much does the stock move up / down on average in any given day? Are you comfortable with these moves? If not, it may be worth considering a safer company to invest in. In other words, if you’re not comfortable with the wild swings that come with owning Tesla stock for example, you may be better off considering safer names such as Coca Cola or Unilever!
Broader Financial Market Context
1. Stocks vs. Other Asset Classes: It’s worth looking at whether stocks on the whole have been performing well versus other asset classes – what do people think? Have stocks become too overvalued? Or are they undervalued in general right now? Having a good sense for this can help you time your decision better to get the most out of your investment!
2. Financial markets in general: Before making that final investment decision, it’s also worth catching up on the latest financial news headlines just to make sure you know what’s going on with the “big picture” and whether any external factors such as geopolitics (Trade war / Brexit!), environmental issues (multiple wildfires!) or global events (anything from pandemic outbreaks to the Olympics) are likely to impact the company and industry you’re considering investing in. If there is a likely impact, will it be beneficial or harmful for your investment?
While it’s almost impossible to be on top of every single factor which may affect a company’s share price, taking the above into consideration when investing can definitely help you make investment decisions with your eyes wide open.