In my last post, Stock Market Basics, we discussed what stocks, shares, dividends, and brokerages are. Now, it is time to put that knowledge to good use and learn the art of buying and selling stocks. Knowing everything about how the stock market works is useless if you throw all your money into shaky companies that trend downwards. We will start off with buying stocks.
Buying Stocks
This post will not be able to tell you the 10 stocks to pick that will make you rich. If anyone tells you they have that knowledge, they are lying to you. The purpose of this post is to instead give you a foundation to use to make your own decisions on stocks. Picking stocks involves innumerable factors, but a lot of it involved opinions about where a company is heading. We could both look at the exact same company and one of us feels that the company has a weak foundation and the other feels it could be the next Google.
The Goal
Money. Right? Yes, very astute observation. But the trick is how. The goal with most stock purchases is to buy a strong company, hold them for the long term, dollar cost averaging over time, reinvest dividends if possible, and watch compounding work its magic. This is the assumption that most of the below information will focus on and is historically the best way to make money in the market.
A secondary and more risky option is to buy stocks that you hope will shoot up in the short term. As you can imagine this is very difficult to achieve, as if you know that a stock is going to shoot up soon, then everyone would, causing the stock to already be high. Your hope here would be to get in on a stock that is either being massively shorted or has upcoming projects that you believe will result in a fantastic performance that most people think will flop. Either way, this is not a method of investing that I am currently knowledgeable on, so best of luck.
Diversification
Picking stocks isn’t like picking your nose – you have far more than two options. There are over 2000 stocks on the New York Stock Exchange, the US’s primary stock exchange. When selecting companies to invest in, you don’t want to pick only one or two companies. If one of these companies has a massive scandal, goes bankrupt, or even misses their revenue predictions significantly, their stock price, and hence the majority of your portfolio, can be greatly affected. On the other hand, if you invest in all 2000 companies equally, you will be investing in many companies that skyrocket, and many companies that run towards 0$ like it’s going out of style. This will result in unpredictable results that lead nowhere.
Having a properly diversified portfolio means a portfolio that follows few enough stocks that significant gains can ride significant gains in one or two stocks, while still following enough stocks that a fall in one or two stocks will not hurt you. The rule of thumb is to own 12-20 different stocks approximately equally so that each stock makes up between 5-10% of your portfolio.
I mentioned previously that it isn’t absolutely necessary to go through the effort of picking individual stocks. There are many index funds that follow the market as a whole. I personally use ticker VOO, as this fund charges low management fees. Regardless of which exact fund you use, an index fund automatically introduces diversification. VOO follows the top 500 companies in the stock market, weighted by market cap. This way, you can invest in many companies, but still have a greater portion of your money in large stocks. Currently, Apple makes up ~7% of the fund and Twitter makes up ~.1% of the fund. Simply investing in this market fund will allow you to perform well without much effort.
Stock Data
Each stock on the NYSE has a “ticker”. This is the short string of capital letters, usually 1-5 characters long, that represents the company’s stock. For example, Apple is AAPL, Visa is V, and Starbucks is SBUX. When you look up a company on a brokerage or an online financial tracker, a company’s ticker is usually easier to search by than its actual name.
Each ticker on the stock market has a set of values and statistics alongside it that can give you an indication of the company’s current and past standing. There are hundreds of different values analysts may use, but a few quick and dirty ones are:
- Market Cap – The total cost to buy all of the shares of a company’s stock at its current share price. Not necessarily the same as the cost to acquire a company.
- P/E – Price to Earnings – A ratio indicating whether a stock price is expensive for the earnings it provides. If a company costs $100 million to purchase and generates $100 million in earnings, it has a P/E of 1. Generally, companies in the 10-25 range are seen as fairly valued.
- Dividend Yield – Ratio shown as percent of dividend/share price. For example, a $4 dividend with a $50 per share stock has an 8% yield.
- 52-Week Low – Lowest share price in the last 52 weeks. This can give you an idea of whether a stock is currently cheap or expensive relative to its previous prices. Understand, this does not mean that a stock is actually cheap or expensive, it is only relative to its previous price. Even if a stock is at a 52-week low, it may have been overvalued and expensive for the last year, making it just a decent price now.
- Revenue – The total income a company brings in from its products or services.
- Revenue Growth – The growth year over year of a company’s revenue.
- Operating Margin – How much of a company’s revenue is actually kept as profits after expenses are deducted. If a company can sell a product for 1$ and it cost the company $.50 to produce, market, employ salespeople, etc. to sell the product, the company has a profit of $.50. Resulting in a 50% operating margin.
Where to Acquire Stock Data
Most stock data is available through your broker, depending on the broker you go with. TDAmeritrade provides a massive amount of data, which is very useful and easy to track inside your account. In contrast, Robinhood does not provide nearly as much data in the app, opting to only provide the basics. As a reminder, if you join Robinhood using my link, we both get a portion of a free stock.
Regardless of what broker you go with, you will likely need to use an outside source to obtain important numbers such as revenue growth and operating margin. There are many websites that provide this info such as Yahoo and Google finance, but I personally recommend quickfs.net. They are in no way a sponsor or anything, but they provide in-depth data for free. The only downside is they do not define any of the terms on their website, so you may have to look up the definitions of a lot of the data on your own.
Technical Stock Analysis
There is no foolproof method for stock picking. A lot of it comes down to luck, and even those that aren’t as lucky could be using a variety of methods to achieve more consistent success. The truth is that there are numerous major successes and failures in the stock market every day. There are plenty of successes and failures to go around, all able to be found in different ways.
The first and more easily understood is technical analysis. My purpose here isn’t to explain complex technical analysis as people study for decades to fully understand the technical market analysis, and that’s not one of my duties as an engineer.
Technical analysis is based on using the above stock metrics to gauge how a stock has performed and hopefully how it will perform in the future. For example, if you see a company has stagnant or even declining revenue, shown as 0 or negative revenue growth, this may indicate that the company is having trouble acquiring as many customers as it did previously. Vice versa, if a company has had revenue growth increasing every year for the past 5 years, that is likely a strong, growing company that is managing to pull in more and more customers every year. Another example is that if a stock is at or near its 52-week low, it may be a good deal.
It is important to be careful with technical analysis, as without qualitative analysis of a company, technical analysis can lead you to incorrect conclusions. For example, a stock may be at its 52-week low, but it was overvalued a year ago. If the stock market was constantly increasing for years and the stock’s P/E shot up to 80, and it has now plummeted to 40, it may still be overvalued. In addition, a company with a growing dividend but decreasing revenues may be attempting to make itself more attractive to investors by cannibalizing its own profits.
Qualitative Analysis
Equally as useful as technical analysis is qualitative analysis. This could include anything from the company’s social media standing to the public’s view on their new CEO, to the public’s shift to healthier food. Even though we all want to believe we are emotionless investors, none of us are. We enjoy investing in companies whose products we use on a daily basis and who we see as a virtuous, positive influence on the world.
For example (my two favorite words based on this post), over the past 10 years, Tesla (ticker TSLA) had a median P/E ratio of 346 (see above). Three hundred and forty-six, versus the recommended 10-25. A reminder that until 2019, Tesla wasn’t even making money. They lost money every year, but investors continued to buy into the future of the company. I think we can safely say historically that these investors made the correct decision, but this was mostly based on qualitative analysis of the automotive market and the direction it was heading.
Selling Stocks
No matter what happens to your portfolio, you don’t make a penny until you “realize your gains” and sell your shares. If you are holding stocks for the long term, i.e. retirement or a far-away purchase, there is no reason to sell shares of a strong company. By selling a stock, you interrupt the compounding of the dividends and gains. Also, if you sell a stock within less than a year of when you purchased it, you pay a higher tax on any gains. However, this doesn’t mean you should never sell your shares in a company.
You Need Da Money Now
If you are finally looking to use part of your portfolio to purchase something such as the down payment on a house or car, or to begin using for retirement, you must sell some of your shares. However, if you have two stocks, one that is performing well and shows no sign of stopping, and one that is falling with no sign of recovery, you should sell the falling company. You don’t want to interrupt the compounding of the growing company, and if you need to withdraw say $1000, that $1000 will continue to make money if it stays in the growing company, whereas it will only be devalued over time in the falling company.
The Ship is Sinking
There is a saying in investing: “Don’t be left holding the bag”. That is to say, don’t be the one left holding shares of a company that has now gone bankrupt or is near bankrupt. To be clear, this does not mean that just because a stock has begun declining, you should sell. A sinking ship is one with a poor forecast whether due to shrinking demand, poor leadership, or shrinking margins. If a stock begins to have a very negative outlook and has dropped 50%, it now has to double to return to where it once was and allow you to break even. Your money would be better off elsewhere earning more reliable gains with another company.
Panic Selling
One of the major reasons people lose money in the stock market is panic selling when the market or a company drops. I spoke about this in my previous post, but if a company’s stock drops with no real changes to the core of the company, it will more than likely recover soon-ish. Of course, you can never predict the market, but every single company’s stock drops significantly at one point or another. Yet, the vast majority of them recover. Therefore if you sell all your stocks when the entire market crashes due to a pandemic, you are going to miss out on all of the gains during the recovery period.
As Warren Buffett, likely the greatest investor of all time says, be greedy when others are fearful, and be fearful when others are greedy. When the market is in a downturn due to overall public fear and apprehension, jump on that opportunity. When the market is soaring to all-time highs month after month, pull in the reigns a bit.
To Da Moon
This is likely the simplest rule to follow, and also by far the most difficult to perform. This comes down to controlling your emotions. If you buy a stock and it shoots up 50%, 100%, or 200%, sell. that. stock. You don’t have to sell your entire position, but realize your gains before they disappear.
I have a friend who owned a few hundred bucks of AMC before it shot up and his shares were worth ~$20,000. He sold a small number of his shares, but he got greedy and held on to the vast majority of it, which plummeted back down to ~$1,000. Still a ~100% gain, but nowhere near $20,000. If you see that sort of crazy increase, realize most of your gains. Even if you miss out on 10% more gains, you won’t regret holding it too long and watching your 200% gain drop to 0%.
Want More?
I really hope that you were able to learn something from this post. There are so many topics to cover, that many of them only get quickly covered. If you want more info or detail on anything presented here, please contact me or leave a comment on this post. If it is a complicated-enough question, it may even turn into a future post! Best of luck buying and selling stocks. Stay safe and I’ll see you next week.
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