Ways to invest in stocks

July 19, 2018

There are thousands of  investors who want to own ‘good’ companies that avoid ‘trouble’.

  • they invest in stock shares [stock shares are equal units of part ownership]
  • a good company
    • operates a profitable, growing business
    • avoids financial distress and regulatory penalties

Investors purchase and sell shares in the stock market.  They hope to sell their stock at a desirable price and may also receive cash rewards from companies that pay dividends.  Investors earn a profit (called a capital gain) when the sales price is above their cost of investment or lose money (called a capital loss) when the sales price is below cost.  

Stock Analysis

Two ways of evaluating a stock are called technical analysis and fundamental analysis.  Technical analysis measures the performance of share prices and share volumes in the stock market.

  • Shares are units of part ownership which are traded in the stock market.
  • Price: the price of a share in the stock market.
  • Volume: the total number of shares traded in the stock market 

Fundamental analysis evaluates the business performance of a company by way of searching through its quarterly and annual filings.  The business description, financial statements, and CEO’s annual letter to shareholders are important sections of the filings.

  • CEO: Chief Executive Officer; top manager of the company.
  • Filings: periodic reports to shareholders that are required by the U.S. Securities and Exchange Commission (SEC).

Business performance is also assessed by the company’s market share and competitive advantage within its industry.  This information is available online.

Investment Strategies

The most common investment strategies for stocks are swing trading, value investing, and growth investing.  

Swing trading (cyclic trading) uses brief upward or downward trends in share prices to determine when to buy or sell stocks.  The typical holding period is from one day to several weeks.  The investor hopes to earn a capital gain (–if seeking a profit–) or capital loss (–if seeking to reduce the short term capital gains tax–).  The investor uses either a technical analysis or guesswork to judge the price trend.  The main risks of incurring a loss are due to price volatility and taxation of returns.

  • Hold: to own.
  • Short term: one year or less.
  • Short term capital gains tax: the taxation of a capital gain at the regular income tax rate.
  • Price volatility: the random fluctuation of prices based on the market forces of supply and demand.
  • Return: the profit or loss from an investment.

Value investing seeks a capital gain by purchasing the stock at an unusually low price (e.g., 60% of intrinsic value) and then selling it at approximately double the purchase price.  The holding period depends on the length of time for the stock price to become profitable. During the holding period, an investor will receive any dividends paid by the company.  The informed investor uses a fundamental analysis to assess the quality of the company and the intrinsic value of its stock.  The causes of an unusually low price include a market downtrend (e.g., economic recession) and poor company performance.  The main risks of incurring a loss are due to an eventual delisting of the company and taxation of returns.  

  • Intrinsic value: the share price calculated by a professional analyst’s secret formula.  However, you can estimate the intrinsic value as the net worth of the company (book value) per share, based on the idea that a wealthy investor could acquire the company at its intrinsic price by puchasing all shares of stock at the book value per share.   
  • Dividend: a cash reward paid to share holders from the company’s profits or cash reserves.
  • Delisting: removal of the stock from the stock market for various regulatory reasons, including bankruptcy of the company.    

Growth investing is a long term strategy for using the upward momentum of share prices to earn a capital gain. The capital gain is earned by simply holding the stock and reinvesting all dividends.  The rule of 72 estimates the holding period needed to double the purchase price of the stock at an assumed rate of annual return.  The growth investor uses a fundamental analysis of the company and market valuation to judge the fairness of the stock price.  The main risks of incurring a loss are due to deterioration of the company, decline in market value, and taxation of the returns.

  • Long term: after one year.
  • Momentum: an upward trend of share prices.
  • Rule of 72: [ Years to double the price = 72/percentage annual rate of return ] For example, a 15% annual rate of return will double the share price in 4.8 years. 
  • Annual rate of return: a constant percentage change in value every year that accelerates the growth of an investment; CAGR is an acronym for the annual rate of return.
  • Valuation: the art of judging if the price is low (discounted, undervalued) or high (expensive, overvalued). 

disclaimer: this article may not increase your investment profits.

Copyright © 2018 Douglas R. Knight


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