How To Choose The Right Stock For Beginner Investors

The Stock Market.
3 simple words.

Amazing how just those 3 simple words can conjure up a multiplicity of images…to some, the words invoke a vision of wealth, and success. To others, they invoke a vision of mystery, fear and potentially devastating financial loss.

Why the difference in perception? What causes some people to be afraid of investing in the stock market for fear of choosing the wrong stock to invest in?

Well, a lot depends on our past experience with the stock market. Maybe we know someone who lost money on it. Maybe it was a family member. Maybe we were the ones who got burned when a particular stock price plummeted or when the market crashed. Such experiences are negative and so, they negatively impact perceptions. Understandably, the new investor could be afraid to invest.

This article is designed to help you overcome the fear and prepare yourself to start investing in the stock market. Because regardless of your past experiences and perception of investing in stocks, stocks cannot be ignored as a viable asset class for investment. The reality is, if we are able to pick the right stocks at least some of the time, the value of our investment in those stocks can increase exponentially.

At the same time, it is good to take a prudent and cautious approach. Do not assume that you will be the next Warren Buffet. Instead, approach the stock market with caution. There is no such thing as a free lunch, and likewise, successful investing in stocks requires diligence, hard work, patience, control over your emotions and the willingness to work hard to understand technical and financial information yourself.

In other words, you need to commit to putting in the work. It is not a good idea to buy stocks simply based on “tips” from your family members, friends, neighbours, taxi drivers and various other people including your car mechanic and the fish seller from the pasar malam! ?

The first thing to understand is that buying individual stocks offers you significantly higher potential returns than investing in an exchange-traded fund, mutual fund or other class of bundled security that tracks a group of stocks. But it is also prudent to note that, you are exposing yourself to a higher risk of incurring losses as well.

So, choosing the right stock cannot be left to chance or luck or tips from friends. Here are a few simple tips for the new investor in choosing stocks which hopefully, will help you in your investment decisions.

If you don’t know, let it go. Pick stocks from an industry or company that you know about. Or at least, know something about. Preferably, well-known and reputable companies. Go for industries you understand, ones for which there is an existing and recurrent market. Look for consistency in profit over several years, not just how the company is doing right now.

It may be tempting to invest in “high-tech” companies which toss around a lot of cool-sounding buzzwords, but if it’s not immediately apparent how they are making money, it’s probably better to avoid the stock.

Do a financial health checkup.

Don’t be attracted to undervalued stocks with a low P/E ratio simply because they seem cheap and you think you are getting a good deal. Instead, look carefully at the financials. Consider the company’s prospects for future growth. Compare the price of the stock to other industry players. Sometimes, an “expensive” stock with a high P/E ratio, could be more valuable to you in the long run.

And if a stock price is going down, don’t assume you should buy because it is cheap, assuming that the price will go back up. The key question to consider is, when and how is the price going to rebound. If the answer is not clear, best to avoid the stock.

Show me the money.

Yes, that oft-quoted line from the movie “Jerry Maguire” applies here too. Before deciding to invest in a particular stock, the question to be considered is, can the company grow its revenue and if the potential for that is apparent, then what timelines we are looking at in order for this to happen. Again, it’s easy to get caught up in hype generated by ad campaigns and media coverage. Always go back to the financials.

Look at how much debt the company has and how such debt is financed. Also look at the management team and board of directors. Is this company well-positioned to expand its business in Malaysia and overseas? Is there an indication of solid and immediate potential for revenue growth in the short-term?

Also, look carefully at the profit margin to be sure that while there may be strong revenue growth/growth potential, there is also a prudent policy in place to manage expenses so that the profit margin has room to grow.

What’s in it for me? What else, but the inevitable question at the crux of any decision to purchase shares. Yes that’s right, the question surfaces during every discussion on stocks. “That stock got dividend or not?” ?. Of course, it is right that we should ask this question.

As investors, our aim is to grow our portfolio and increase our returns. So the question as to whether a particular stock is dividend-yielding is in fact a very pertinent one. Companies which pay our regular, and preferably increasing, dividends are usually well-managed and in good financial health.

Spend time to make money.

A final tip would be to invest time, a lot of time, in doing your own research and analysing all the information available to you out there. Online and offline, there is no shortage of financial information. For starters, check out Bursa Malaysia’s website, the Edge Financial newspaper, and tune into BFM Radio Channel 89.9 for regular updates on the stock market and the performance and outlook for individual stocks.

So, newbies, happy stock picking and good luck for 2015!