Monday, September 1, 2014

4 keys to better stocks investing

Many of us want to invest for many different reasons. Some want to make money through buying stocks, others think that the bank's interest rates are too low so they seek to find ways to earn more interest. In other words, the trigger point for most people to invest is making more money. Those who're not interested in making money may never even think of investing in the first place. There are a few exceptional cases where investing is taught at home. Warren Buffett is one of them where his father was a stock broker so Warren Buffett was exposed to the world of stock market at a very young age. He went on to have many mentors such as Benjamin Graham and Philip Arthur Fisher who taught him the essence of value investing.


But for most of us, we're not so fortunate to have people to guide us on investment. Many of us put our hard earn money into stocks without much knowledge. In an effort to make more money, we instead lose money then start learning through the hard way. It seems like a natural process which every investor has to go through before succeeding.

However, if you're a new investor and want to start investing, today i'll share 4 keys you need to know before you start investing. Hopefully this will reduce your risk and make your investment journey a smoother one.


1) Financial ratios do not make sense if you don't understand it

Many new investors try to find the holy grail in investing. They learn a few financial ratios such as PE and PB ratio then try to find out at what levels to buy a stock. PE ratio below 10 means buy? PB ratio below 1 means buy? All these do not make sense unless you understand the concept behind these ratios. Try to understand the ratios instead of relying on a fix number to invest.

2) Understanding how a business operate is important

Investing is not about gambling or buying blindly. You need to know how a business generate its profit. If you can't figure out this source, don't invest in that company. If a business can't generate profits, then putting your money into that company is highly risky. 

3) Know the financial health of a company

Is the company spending too much or borrowing too much money? We know that as individuals, if we spend more than we earn, we'll run out of money one day. If we take debts more than we can handle, we may go bankrupt one day. It is the same with a business. A company which is spending more than it earns or borrows too much money is the one you should avoid investing in.

4) Learn the language of business

The language of business is accounting. I cannot stress enough the importance of accounting knowledge in investing. Do you know how to read the 3 financial statements namely the income statement, balance sheet and cash flow statement? Do you know how to refer to the notes to the financial statement to look deeper into each individual entries?

For example, the revenue in the income statement will show you how much money the company made selling its goods and services. However, to know where the revenue comes from, we can refer to the notes to see the breakdown of revenue from different sources.

Let's see an example from Breadtalk's financial statement. In 2013, Breadtalk's revenue was $536,530,000 as seen in the income statement below.

Adapted from Breadtalk 2013 Annual report
Click to enlarge

To see the breakdown of the revenue, we can look at the notes to the financial statement at the back of the financial report. It is indicated as notes 3 so this gives us the exact page to go to. Below shows how the notes look like.

Adapted from Breadtalk 2013 Annual report
Click to enlarge

From the notes to the financial statement under 3, we can see the revenue breakdown. The entries recorded are bakery sales which supposedly is from its Breadtalk bakery, restaurant sales from its Din Tai Fung, Ramen Play and other restaurants which it might have, sales to franchise, franchise income and lastly its food court income from its food republic. Now we know where most of its income comes from which is from its bakery sales. It's food court income comes in second. 

There are many more interesting things we can find from a business if we understand the language of business which is accounting. The good news is accounting can be self learnt and as investors, we don't have to know everything. We just have to know a few key stuffs. Hopefully, the 4 keys above will guide you to the right track in your investments. Understanding how to invest makes it more interesting than just investing without knowledge. Remember, as a shareholder, you own part of the company. An owner will want to know what is happening in his or her company.

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Related Posts:
1. Understanding financial statements (Part 1) - The income statement
2. How to pick stocks (Part 2) - The profitability of a business

8 comments:

  1. 1, 3 and 4 are relatively easy.. point 2 comes w life/work experience, keen business acumen, great observant skills.. its an art and the hardest to learn

    ReplyDelete
    Replies
    1. Hi CSCCC,

      Indeed, its never easy to understand any business operations especially when we're not in that industry. We learn from experiences and also sharing from others who're in that industry. But sometimes, even if others share with us we won't be able to understand it easily. It is good to start investing in an industry we're familiar in for a start.

      Delete
  2. After 10 or more years in investing, most retail investors will acquire more than enough knowledge in FA and TA, what is lacking is their emotions control over market cycles.

    ReplyDelete
    Replies
    1. Hi Uncle CW,

      Indeed emotional control is important in investing. It is even more important in trading.

      Delete
  3. Good read, thank you for the post.

    ReplyDelete
  4. Hi SGYI!

    Nice write up again! This article is extremely useful for me as a new investor! Will be sure to note them down in my notebook! Thank you!

    Regards,
    The Independent Abecedarian

    ReplyDelete
    Replies
    1. Hi TIA,

      Glad you liked the article. :)

      Delete