How to Invest in Stocks

from wikiHow - The How to Manual That You Can Edit
Everyone wants to be financially secure. Although your house/condo is probably your biggest asset right now, you will need to live in it for the rest of your life. Do you want a comfy retirement or a vacation house in the South Pacific? You must invest your savings if you plan to retire rich.Â

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Steps

1. Save. Before you can invest, you need money. Don't start investing until you have property, $10,000 in savings (to be kept in savings) and another $10,000 to start investing with.
2. Read. Warren Buffett made his entire fortune investing, and has lots of very useful advice for real people who want to invest. Motley Fool is an excellent online publication, as is the Tycoon Report, and Wikinvest.com is great place to find information on companies and concepts in the market.
3. Buy a small portfolio of stocks. Blue chip stocks perform well, and are often fairly priced. Stay up to date with different value investing websites such as Motley Fool or Fallen Angel Stocks to see what kind of deals are out there. If you do not have the time or motivation to learn about individual stocks, mutual funds provide a low risk investment that follows the market trends very closely.
4. Forget about it. Avoid the temptation to sell when the market has a bad day.
5. Invest in a regular and systematic manner. Set aside a percentage of each paycheck to go into savings. Always leave at least $10,000 in cash around for emergencies.
6. Consider selling portions of your holdings as a stock appreciates. This bias of selling losing stocks quickly and completely and selling gaining stocks slowly and partially may increase your long-term chance for success.
7. Consult a broker and take part in simulated stock experiences. Read as many books and articles as possible written by experts who have successfully invested in the types of markets in which you have an interest. You will also want to read articles helping you with the emotional and psychological aspects of investing, to help you deal with the ups and downs of participating in the stock market. It is important for you to know how to make the smartest choices possible when investing in stock, and even if you do make the wisest decisions, to know how to deal with loss in the event that it happens.
8. Learn how to budget your money and to spend your earnings wisely. Most investors have to be careful not to spend any of their profits, and to keep some aside for future use, and for retirement, as well as emergencies.

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Tips

• The share price of a stock has no relation to whether the stock is cheap or expensive. Refer to Motley Fool, Better Investing and other groups of "value investors" for advice on determining the fair value of a stock.
• Start a Roth IRA. You can save hundreds of thousands in tax dollars in the long run.
• Buy companies that have little to no competition. Airlines and energy companies are generally considered bad long-term investments.
• Try not to restrict yourself to any particular type of company. Understand that companies are in a sense 'black boxes' that generate revenue and profits--by becoming able to evaluate a company beyond a superficial glance--using Morningstar.com "5-Yr Restated" financials will help--you will be able to identify stocks in companies you haven't heard of and others haven't either--yet deserve your attention.
• Companies with strong brand names are a good choice. Coca-Cola, Dell, 3M, and GE are all good examples.
• Understand 'why' companies like blue chips above turned out to be good investments--their quality is based on their prior history of consistent revenue and earnings growth. By being able to identify those types of companies prior to everyone else, you will be able to reap larger rewards in your investments. Learn to be a 'bottom up' investor.
• Companies with virtual monopolies like Microsoft and Wal-Mart are good investments if you can find them at a good price.
• In general stay away from seasonal or trendy industries like retail and regulated industries like utilities and airlines, unless they have shown consistent earnings and revenue growth over a long period of time. Few have.
• Cyclical stocks may have periods of strong growth followed by times of contraction. They may be difficult to own by the amateur investor.
• Invest in companies that are shareholder-oriented. Most businesses would rather spend their profits on a new private jet for the CEO than pay out a dividend. A return on equity (a common statistic) greater than 15%, a 2% dividend and large cash reserves are evidence of shareholder-oriented companies.
• Buy companies that are in profitable industries. Look for companies with profit margins greater than 10%. Media and beverages are the classic examples.
• Wall Street focuses on the short-term. You will only beat the market if you hold the stock for many years.
• The goal of your financial advisor/broker is to keep you as a client so that they can continue to make money off of you. They tell you to diversify so that your portfolio follows the Dow and the S&P 500. That way, they will always have an excuse when it goes down in value. The average broker/advisor has very little knowledge of the underlying economics of business. Warren Buffett is famous for saying, "risk is for people who don't know what they're doing."
• If you truly don't know what you're doing, invest in an index fund that is tied to the S&P 500. They will charge only a fraction the fees of other funds because they do not need to do any research.
• Alternatively, if you have the time and energy to learn about the market and it's daily changes, consider learning how to trade options, futures, commodities, foreign currencies, preferred stock, or bonds.
• Don't look at the value of your portfolio more than once a month. If you get caught up in the emotions of Wall Street, it will only tempt you to sell what is probably an excellent investment. Before you buy a stock, ask yourself, "if this goes down am I going to want to sell or am I going to want to buy more of it?"
• Most importantly, remember that you are not trading pieces of paper that go up and down in value. You are buying a share of a business. The health and profitability of the underlying business and the price you will pay are the only two factors that should influence your decision. (In addition, perhaps, to the social responsibility of the business).

Warnings

• Don't blindly trust the investment advice of anyone who will make money off of your buying and/or selling (this includes brokers, advisors and analysts).
• When it comes to money, people lie to save their pride. When someone gives you a hot tip, remember that it is just an opinion.

Sources and Citations

• Stock Advice
• Better Investing
• Small Cap Stock Advice

7 questions to ask before you buy a stock

Putting your money in the market can leave you open to some nasty surprises. Avoid them by doing the right research.

By Harry Domash

Value and growth investors seldom agree on what's important for evaluating a stock. But here are seven questions every investor, regardless of persuasion, should ask before plunking down money:

What does the company do?

Do you know what your company actually does for a living? Is it in a hot growth sector or in a saturated industry whose best growth days are long gone? Or does it make those proverbial buggy whips?

That first question is not as silly as it sounds. Sometimes we become so focused on analyzing the numbers that we forget about the big picture.

You probably know what the company does if you're looking at the likes of Wal-Mart Stores (WMT, news,msgs) or Google (GOOG, news, msgs). But it's a different story when you start examining at lesser-known names. For example, what do Icon (ICLR, news,msgs) and Knoll (KNL, news, msgs) do for a living?

You can find out in a New York minute by checking MSN Money's Company Report pages. Though only one paragraph, each report describes a company's products and/or services in pretty good detail, and it's written in understandable English.

The reports give you more than enough information to gain a feel for the company's products and/or services. For instance, Icon provides outsourced clinical-trial services to pharmaceutical companies, and Knoll makes office furniture.

What do you do with that wisdom? It depends. If you were looking for hot growth stocks, you would probably find Icon of interest but drop Knoll like a hot potato.

On the other hand, value investors, knowing that the market ignores unglamorous industries, seek out stocks such as Knoll in hopes of finding an undervalued gem.

How many widgets is it selling?

Companies are in business to sell products and/or services. We're talking big numbers here. Most publicly traded corporations rack up sales running into the hundreds of millions of dollars annually.

However, as an investor, you often encounter companies with a supposedly hot product on the drawing board but with little or no sales. When you buy such companies, you're buying the "story," which may or may not come to pass. That's risky business.

Risk-averse investors should stick with companies racking up at least $500 million in annual sales. Does that limit the field too much? Not really. When I checked recently, more than 1,700 U.S.-based stocks fit the bill.

More-adventurous investors can go lower, but the risk meter goes off the chart when you get below $100 million in 12 months of sales. At the very least, disqualify stocks with less than $10 million in sales in the most recent quarter.

You can find the past four quarters' figures (look for "last 12 months") on each Company Report page, and you'll spot the quarterly figures on the Highlights reportin the page's Financial Results section.

You can't apply minimum-sales criteria to banks and similar institutions, because their income comes from interest earned, which usually doesn't show up in the sales totals.

Just how profitable is the company?

For stocks, profitability means more than not losing money. Here's why.

Consider two hypothetical companies, company A and company B, both selling widgets for $100 each. After considering all expenses, company A makes $50 on each widget sold, while company B makes $25 per widget. If they both sell a million widgets a year, company A's profit totals $50 million compared with company B's $25 million.

Thus, each year, company A has $25 million more extra cash than company B. It can use that cash to develop new widgets, build more factories, pay dividends, etc. There is no way that company B can keep up with company A's spending without going outside to raise more cash, either by borrowing or by selling more shares. Both alternatives diminish shareholders' earnings.

Obviously, you'd be better off owning stock in company A than in company B, but how do you know which is which? That's where profitability measures come into play.

Return on equity, or ROE, the ratio of a company's 12-month net income to its shareholder equity (book value), is the most widely used profitability gauge. But relying on ROE has a downside. The way the math works, all else being equal, the higher the debt, the higher the ROE.

By contrast, you calculate return on assets, or ROA, by dividing net income by total assets, which includes liabilities. Consequently, all else being equal, the lower the debt, the higher the ROA.

You can see ROAs in the Investment Returns section of the Key Ratios report (under Financial Results). Look for companies with ROAs above 10%. Avoid ROAs below 5%.

Growth investors should pay most attention to the trailing-12-months ROA. However, because value stock candidates may have recently stumbled, value investors should focus on the five-year-average profitability figures.

Is cash flowing in or out?

Cash flow measures the amount of money that moved into or out of a company's bank accounts during a reporting period.

Cash flow is a better profit measure than earnings because it's harder to finagle bank balances than numbers like depreciation schedules that figure into earnings. In fact, many companies that report positive earnings are actually losing money when you count the cash.

Operating cash flow measures the cash flow attributable to the company's main business. You can find it on either the quarterly or annual cash flow statement (see Statements under Financial Results). However, the quarterly statements are timelier. That said, be aware that the quarterly cash flow columns reflect the year-to-date (cumulative) totals, not the individual quarters' results.

You want companies with cash flowing in, not out. So look for positive numbers in the Net Cash from Operating Activities row. Though any positive number is OK, it's best if the operating cash flow exceeds the net income (top line) for the same period.

Is the company submerged in debt?

High debt is not always a bad thing. For instance, there's nothing wrong with a company borrowing at 6% if it can put the funds to work earning 12%. Nevertheless, the higher the debt, the more susceptible a company is to rising interest rates. Rising rates result in higher debt-service costs, which subtract from earnings.

The financial leverage ratio (total assets divided by shareholders' equity) is an all-purpose debt gauge. A company with no debt would have a financial leverage ratio of 1, and the higher the ratio, the more debt.

As a rule of thumb, avoid companies with leverage ratios above 5, which is the average of S&P 500 Index($INX) stocks, and lower is better.

You can't apply the leverage ratio -- or any other debt measure, for that matter -- to banks or other financial organizations. For them, borrowed cash is their inventory. Financial companies always carry high debt compared with companies in other industries.

Any bad news lately?

Negative news, such as an earnings shortfall, problems with a new product or an accounting restatement, not only pressure a company's share price but often portend even more such news on the way.

Bad news is the death knell for growth stocks, and growth investors should avoid all such stocks.

Even value types, who seek out stocks beaten down by bad news, should wait on the sidelines until they're reasonably sure that there is no more to come.

Think months, not weeks.

Take a look at the company's latest doings by selectingRecent News at the left of a stock's quote page.

Which way are forecasts moving?

There is much to be gained by paying attention to analysts' earnings forecasts.

MSN Money displays consensus earnings forecasts for most stocks. These are the average forecasts from all analysts covering a stock. The consensus numbers tend to move in trends. Why? I'm not sure. One reason may be that after one analyst makes a significant change, others re-examine their models and then revise their estimates in the same direction.

Changes in consensus earnings forecasts move stock prices. A positive forecast trend moves prices up and vice versa.

You can use the Consensus EPS Trend report (under Earnings Estimates) to see current, next-quarter and fiscal-year estimates going back 90 days. Focus on the fiscal-year data and ignore 1-cent changes. Avoid negatively trending stocks -- that is, stocks for which the latest fiscal-year estimates are more than 2 cents below the figures of 90 days ago.

Answering these seven questions will help you make better investing decisions, but they are just a start. Dig deeply and learn all you can. The more you know about your stocks, the better your results.

At the time of publication, Harry Domash owned or controlled shares of the following company mentioned in this column: Icon.

Published Oct. 14, 2008