Here is an excerpt of an email from Steph, a fresh graduate who is searching for answers in regards to investing.
Investing in the stock market is risky. How do I choose which stocks are profitable and able to generate higher returns in the short-term? Should penny stocks be considered since they are lower priced and highly speculative? I know that trading penny stocks can wipe your investment out easily. Or, is it better for me to invest in blue chips where they are more established and are financially secured?
Before I begin, I would like to express my gratitude to Steph for her question. It is valid and I find that it reveals a lot about what most people think and perceive about stock investing, which is quite far from what true stock investors think and do. In this article, I’ll dissect the email received sentence-by-sentence to reveal our differences so that all would have a much better understanding on what true stock investing really is.
They are as follows:
1. Investing in the Stock Market is Risky.
Stock investing is not risky. Buying shares without knowing what you are getting into is very risky. It is a lack of knowledge that killed many sincere people who intend to make money in the stock market. If you ask people why did they lose money in the stock market, in most cases, you’ll find that they did not do any sort of homework or research before buying shares. That, in essence, is gambling or speculating, but definitely not investing.
2. Higher Returns in the Short-Term
Stock investing is a systematic way of building long-term wealth via investing in a portfolio filled with stocks which are great businesses at their lowest possible prices. This is widely practised by billionaire investors such as Warren Buffett, Charlie Munger, … etc, sovereign wealth funds like Temasek Holdings, pension funds like the EPF and CPF, insurers, … etc around the world.
When they invested their money into their preferred stocks, often, they would hold them for a very long period of time, which could even be for multi-generations or forever. They are not people who try to buy a stock at RM 1 to sell it for RM 2 at the shortest frame of time. These people could be traders, speculators, and gamblers but definitely not investors.
3. Considering Penny Stocks because They are ‘Low-Priced’.
Stock investors aim to buy good stocks cheap. Cheap may not necessarily be affordable (low-priced). A high-priced stock may not be affordable but it can be cheap and of great value. Let me explain:
Supposedly, we have two condominiums located side-by-side. The first one is priced at RM 300,000. The second is priced at RM 500,000. Which of the two is cheaper?
If you say RM 300,000, you might be wrong. Why? What if I add more information to the two condominiums where the first one is a 300 sq. ft studio and the second one is a 1,000 sq. ft. 3 bedroom 2 bathroom unit. Now, which of the two condominiums is cheaper? If you compare the two, you would now say the RM 500,000 one because the unit cost RM 500 psf while the first unit cost RM 1,000 psf. The RM 500,000 unit is of greater value.
Likewise, ‘low-priced’ stocks may not necessarily be cheap. Stock investors would compare prices of stocks with their earnings, book value, and dividends by calculating valuation ratios. This is how stock investors avoid buying into overpriced stocks when most people acquire them thinking that they are ‘cheap’. That is very dangerous.
4. ‘Trading’ Penny Stocks can Wipe Your ‘Investments’ Easily
In a sentence, I found two words: trading and investing. Most people believe that stock investing and trading are the same thing, which they are not at all. It is important to recognise a distinction between the two. Investing is different from trading in terms of thinking and reasoning.
Stock investors want to buy good stocks at their lowest possible prices. Thus, when a good stock falls in price, stock investors are interested to acquire more of them because they are cheap and are of good value. But, stock traders may not do so. In fact, when a stock falls in price, stock traders would avoid buying into the stock as they are more interested to find stocks where their prices are on the rise. The mindset, tool sets, and set of skills are totally different.
5. Blue Chip Stocks are more Well-Established.
Many people think blue chip stocks are stable investments because they are large in size and are recognisable by the public. To some extent, some of these blue chips are decent investments. However, most of them are not. Some of these blue chips do not deliver great financial performance on a consistent basis. it is a mistake to assume that all blue chip stocks are stable investments.
Then, What Should I Invest Into?
I understand. The above explanation may be a little too overwhelming and there could be a chance that you may not fully appreciate all that is written above. That is okay because my intention is to point out that if you have not studied the business model, the finances, management, future plans, and valuation of any stocks, please refrain yourself from investing.
If you can do just that, you would save yourself thousands of dollars from poor purchases in the stock market. Remember, stock investing is not about taking a few bucks to ‘try it out’.
If you are into stocks, may I suggest that you invest a few tens or hundreds of Ringgit and hours of time to read stock investing books? If you don’t know any, you may start with Mary Buffett’s Buffettology. That is a good book to start with and it is regarded as a classic among all stock investors around the world.
Otherwise, you may start by reading some of our articles on stock investing: