Learn what investing pitfalls to avoid, how to find investment ideas, how to research them, and how to filter out bad stocks from the start (so you don’t waste any time on research!). I created this blog post especially for total beginners in the stock market who just want a better understanding of how it all works.
Watch the video below or keep reading to find out the 6 things you should know to get started investing in the stock market.
1. The first thing you need to know is, what IS the stock market?
Think of the stock market as a huge digital marketplace like Amazon, where sellers and buyers come to trade with each other – but instead of buying and selling products it’s to buy and sell stocks.
A stock is a fractional piece of ownership in a business. So when you buy stocks, you’re essentially buying pieces of businesses. If you buy WMT stock, you’re buying a piece of Walmart.
Before the stock market, if you wanted to invest in a company, there was no centralized place to do this so you’d have to track down the owner, contact her, make an offer, and it was very complicated and time-consuming. Now, thanks to the stock market, you can invest in pretty much any company you want all in the click of a few buttons!
2. You need to know how to avoid the pitfall of trading stocks vs. investing in stocks
The second thing you need to know is, the difference between trading and investing. Trading stocks is NOT a reliable way to make money, and it’s very different from investing. With trading, you’re usually in and out of a stock pretty quickly and you rely on chart patterns and signals to predict price moves – this is also known as technical analysis.
A lot of people want to get into stock trading because it seems like a glamorous and easy way to make a lot of money. But trading is a losing game for most people. Here’s why: a lot of super sophisticated professional traders make their living by trading in the stock market, and generally, you have no edge against these players.
You’re competing against lightning-fast algorithms and well-capitalized institutions that have access to top-of-the-line tools and information. It’s like trying to win a race against a Ferrari when you have a Toyota. It’s possible, but it’s unlikely. So even though stock trading sounds really cool, I would really think twice before risking your lifesavings on it.
Investing is a totally different story. You’re usually holding your stocks for years, because it takes time for a great company to reach its full potential and give you the maximum profit. Instead of looking at price charts and doing technical analysis, you’re reading annual reports and studying financial statements.
And as a small individual investor, you have the edge. One of the keys to choosing great investments is the ability to keep a long-term perspective. But most professional fund managers can’t do that, because they have to report their returns every quarter and are under a lot of pressure to keep their jobs.
Best of all, you have access to the same information as all the big players do. You’ll find everything you need to know about a company by looking up its SEC filings, which tell you everything you need to know about the company before you invest. Keep reading to find out how to look up SEC filings for your company.
3. You need to know how to quickly come up with stock investment ideas
The easiest way to do this is to think about the products and services you’re already using in your everyday life, and then find out if you can buy stock in those companies. Just thinking through a typical day in your life will give you at least 10 ideas:
You wake up in the morning, brush your teeth…
IDEA #1: Toothpaste (Colgate, NYSE: CL)
…pick out your clothes and get dressed.
IDEA #2: Clothing (Ann Taylor, NYSE: ASNA)
It’s cold outside so you put on your coat and head out the door.
IDEA #3: Coat (North Face, NYSE: VFC)
Before you get to your office, you make a stop at Starbucks
IDEA #4: Coffee (Starbucks, NYSE: SBUX) for your morning latte.
When lunchtime rolls around you go to Chipotle for a burrito…
IDEA #5: Burrito (Chipotle, NYSE: CMG)
…and you scroll through Instagram on your iPhone for a few minutes.
IDEA #6: Instagram (Facebook, NASDAQ: FB)
IDEA #7: iPhone (Apple, NASDAQ: AAPL)
After a long day at the office you pickup some groceries for dinner at Whole Foods…
IDEA #8: Whole Foods (Amazon, NASDAQ: AMZN)
…and you check your email while standing in line.
IDEA #9: Gmail (Google, NASDAQ: GOOG)
You get home, make dinner, and afterwards you chill on the couch to look up cheap flights on Expedia.com for an upcoming long weekend.
IDEA #10: Expedia (Expedia, NASDAQ: EXPE).
See? 10 ideas! Easy.
You already know a lot about a number of companies, just from the products you use in your everyday life. Start there. If you want to be a good investor, you need to understand your investments inside out, so you’re going to have to do a lot of research and read a lot of company reports. It’s much easier to do this for companies that you actually like.
I also like this approach because it aligns your investing with your values. I value taking care of Mother Nature and the environment. I drive an electric car. I’d probably want to look into planet-friendly companies like Tesla or Solar City. Same with you, looking at the products you use in your life is an awesome way to find investment ideas that align with your values and beliefs.
4. You need to know that you can only buy stock in publicly traded companies
That’s because private companies don’t issue stocks… only publicly traded companies do. All businesses start out as private companies, and once they are able to meet certain requirements, they can choose to go public and start selling ownership shares in the stock market. Most large well-known companies ARE publicly traded, but there’s quite a few that are still private. For example, you can’t buy stocks in Uber, Airbnb, Petsmart, Sephora, SoulCycle, IKEA (as of January 2019).
So now that you have a list of companies that you like, the next step is to narrow it down to just the publicly traded ones. The best way to do this is by Googling it:
…Google, you’re the BEST!
5. The fifth thing you need to know is how to quickly tell if a stock is a good investment
The best way to do this is by looking at the financial statements. Use a website like Morningstar.com that shows you at least 10 years worth of history all on one page, that way you can quickly evaluate whether this stock seems like a good investment.
You want to see a track record of earnings. Earnings is the company’s profit number – or its revenue minus expenses. The earnings should be consistent and trending up. Let’s take Ulta Beauty as an example:
Here you can see that earnings has always been positive AND it’s been increasing every single year for the last 10 years.
You also want to look at a metric called Return On Invested Capital, or ROIC. This tells you how well a company is using its money to generate returns. As an investor, you want to make the highest possible return with as little capital as possible. Stocks with high ROIC give you the most bang for your buck and if you look at ULTA, it has amazing ROIC numbers – at least 20% pretty consistently. So right away, just by looking at earnings and ROIC, you can tell that ULTA might be a stock worth looking into.
On the flip side, let’s look at General Motors:
GM’s earnings numbers are all over the place. Some years it goes down, then goes back up, then most recently it was negative. It’s ROIC numbers are pretty sad too. Never invest your money in a business with a sketchy track record. If you ever see a stock with numbers like this, cross it off your list and move on.
6. Lastly, you need to know where to find good information for the stocks you want to do more research on
I always recommend starting with primary sources rather than blogs and news articles, because you don’t want other people’s opinions to cloud your judgement. So the #1 place where you should always start your research is the company’s official filings. All publicly traded companies are required to file annual and quarterly reports with the SEC, which is a government agency that regulates the financial markets.
You can find all these reports online at SEC.gov under Company Filings. The annual report is called the 10-K and the quarterly report is called the 10-Q. Everything in these reports are written in plain English and will tell you everything you need to know about a company before you invest.
Another great source of information is the quarterly earnings calls. Every quarter, when the company reports its profits for that period, the CEO always does a live earnings call, and these are open to the public. They’ll give you a lot of color on what’s going on behind the scenes in the company and they’re a great way for you to get to know the CEO. And if you miss the call, you can usually get the recording or the transcript on the company’s investor relations website.
Now I have a question for you:
Have you started investing in the stock market? Why or why not?
Let me know in the comments below because I’d love to know!
