Many novice investors are convinced that there’s some magic formula, some “secret sauce”, that’s all they need to make a killing in the stock market. Experienced and successful investors will tell you that nothing could be further from the truth—the secret sauce of investing is to take the long view, learn the fundamentals of investing, and to ignore the daily fluctuations of the market. When you ask your financial advisor for advice on stock picks, ask them why they’ve chosen a particular investment—the why of a stock pick is critical to making profitable decisions.
Five stops on the learning curve for choosing stocks
All the books and reports and white papers that have been written about picking stocks can be distilled into five distinct points. They’re not simply tips, but instead a road map to educating yourself on how to make smart investment choices that will earn you strong returns over time.
Learn the macroeconomic environment
The overarching theme of smart investing is understanding how the Australian economy works, both domestically and as part of the global whole.
Do your reading
Read up on the Reserve Bank of Australia’s quarterly Statement on Monetary Policy for expert opinion on the economy. Subscribe to reputable financial and business publications—newspapers, websites, newsletters—to stay up to date on economic news. Dig deep when bank and brokerages’ research departments publish their economic forecasts.
Topics to follow
You can set your notifications so that you have up to the minute details on any economic news. These are some topics that will have relevant information.
- Interest rates
- Australian economy and government policy
- Investor sentiment
- Regional and industry-specific influences
- Relevant international economies and markets
Learn and understand ratios
One word that pops up a lot in conversations about investing in stocks is ratios. This can be confusing because analysts consider more than one ratio when they’re reviewing a stock, and they’re both equally important.
Debt to equity ratio
We’ve discussed debt a fair amount recently, and how not all debt is bad. Holding corporate debt is not a bad thing—as long as it’s in line with the value of the company. To determine the debt to equity ratio, divide the total liabilities by the total amount of shareholder equity. Industry experts consider a number of .3 or less to be healthy, unless it’s an industry that’s heavy on debt funding—the construction industry, for example. A high D to E ratio puts pressure on profits, which affects share price and dividends, so unless the industry standard is high, watch out.
Price to earnings ratio
You can find a company’s P-E ratio by dividing the share price by the annual earnings per share. If a stock is trading at $60 per share and the earnings for 2021 were $4, then the P-E ratio is 15. That number is a bit below average, but the more important factor is, how does that number stack up against other companies in that industry sector. Averages are just that, and you need the industry specifics to make good decisions. A higher P-E ratio within an industry is generally a better bet, but keep in mind that some stocks are undervalued.
Understanding Dividends
If there is a magic elixir in stock, it’s dividends. Great investors don’t make fortunes churning and burning; they pick steady stocks that pay annual dividends and let that cash build ad infinitum.
It’s true that consistent dividend payouts are an indicator of corporate stability and growth, but watching the ebb and flow of dividends is a strong indicator of how the business is actually doing. A sudden spike in dividends doesn’t necessarily mean great growth, it more likely means the company is desperate for cash and trying to boost investor confidence with a high-income stream. It could also indicate the company has gotten stagnant and isn’t investing in itself.
Alternately, companies will cut dividends from time to time, and this can mean several things. Cutting dividends may indicate a cash flow issue, or a desire to hoard cash when there is economic uncertainty. If this happens a couple of quarters in a row, it could mean the company is having trouble paying the bills—or nothing at all. This is why you look at the whole picture, not just one component.
Educate yourself—read analyst reports, company reports, market news
All of the information you need to make well-informed stock decisions is easily accessible online. You may need to pay for some information, but reputable analysts and economists are worth the minimal subscription costs. Your financial advisor is another excellent resource for getting information on potential stock picks; they have access to things like P-E and D-E ratios, so you don’t have to do the math.
If you’re not sure where to start doing the research, look at the company’s financial reports, usually found on their investor relations website. Look at quarter over quarter numbers, as well as annual reporting, to identify trends—are revenues growing along with earnings, or are there signs of some decline? If the numbers don’t look great, are they putting resources into new lines of business or broadening their customer base?
The more you research a company, the clearer your picture of its growth potential.
Learn patience
Finally, accept that there is nothing certain about investing in the stock market, and be patient with your decisions. Barring economic catastrophe, staying the course with your stocks is usually the most intelligent investment strategy. But, of course, only you and your financial advisor can determine your investment horizon, so staying the course means something different to every investor. Contact Super Network today and examine your investment strategies.
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