Investing in the Stock Market

It is important to know the difference between investing and trading. Many would-be investors get enamored with the idea of constantly buying low and selling high. While it is completely viable to devote years of your life to research, gain a PhD in mathematical finance, and become a day trader, if you’re an average professional who wants to get your money working for you, this is the path of destruction.

Being an investor can mean giving your money up to a financial adviser who will direct your investments and usually takes both a percentage of your wealth and a commission on profits every year. If your planner takes 2+20 (2% of your investment and 20% of your profits) this is like adding a tax burden to you of a 2% wealth tax and an additional 20% income tax! When you put it in those terms, financial planners skim a lot of cream from the investments they manage and if you’re savvy, you’re way better off directing your own investments.

Self-directed investment is fraught with its own risks – you now have enough rope to hang yourself and if you put everything on some speculative penny stock, you’ll likely be wishing you had given up that wealth tax to a planner. What you want to do as a cautious investor is buy safe, monolithic growth stocks, diversify across sectors, and maybe make a small diverse play into something speculative when you have good reason to like it.

For example, the bulk of my investment is in liquor and tobacco at the moment. Despite any moral objections one may have to owning these companies, I’m very bullish on Altria (NYSE::MO) and Diageo (NYSE::DEO). Both of alcohol and tobacco consumption increase in financial hard times – this may be counterintuitive, but when people have lower employment and less income they actually drink and smoke more. I also like the way in which these companies think, the way they market, and the way they grow. They also pay good dividends.

Whatever your favorite sector, when you’re shopping for growth stocks, you want to see a history of steady increase and you want to see a good dividend being paid. You also want to see a low P/E ratio. The P/E ratio is the most basic metric for a stock and measures the price of the stock against its annual profits. If a stock has a P/E ratio of 10, for example, and the share price is $50, then the company is generating an annual profit of $5. Effectively the P/E is the number of years it’ll take a share in the stock to pay for itself. Forward P/E is the P/E of the company one year in the future as predicted by analysts. The PEG ratio is P/E/G – basically it is the P/E ratio divided by projected growth, so a company that makes very little profit now, but has a big potential to make a lot of money in the future will have a lower PEG than its P/E.

You also need to look at market capitalization. That is, how much is the whole company worth. If a company has one billion shares and each share is worth $20, the the market cap is twenty billion. In general, the bigger the company, the safer it is. A cautious investor wants to own large cap companies more than small cap companies.

A company that pays a 4% dividend and has a P/E ratio of 10, for example, with a 50 billion dollar market cap is an industrial juggernaut. If the company has a long history of performance like this, it smacks of something you want in your portfolio.

Start small with your investments, but buy into big, well established companies that have a proven track record of making a solid profit each year. As you gain experience and as you read news on the companies you’ve chosen every day, you’ll gain more and more experience, learn more of the jargon, and start to learn about moving averages, bollinger bands, and the more exotic statistical measures of an equity.

Remember that investment is always a gamble and any money you put in your portfolio has a chance of vanishing. The lower risk your investments, the less risk you take with your hard earned savings.