Investing for the first time can be daunting – particularly when you are building your own portfolio by buying (and selling) company shares. Investing in the stock market is a zero-sum game, meaning that for every winner, there is a loser. While picking the wrong stock(s) at some point is inevitable, we round out our top tips for ensuring that you end up with more winners than losers and that you can expertly navigate the sometimes wild and always unpredictable ride.
1. Invest in what you know
“Where do I start?” is a question we get from clients a lot. Considering that there are not only opportunities available on the JSE, but often the opportunity to buy stocks internationally, would-be investors can get bamboozled by the breadth of opportunities available.
It is easy to get lost in all the names available to invest in, but the best place to start is to look at the companies you know. Some examples:
- You have switched your grocery shopping from Pick ‘n Pay to Checkers because you love the Sixty60 app. Add Shoprite to your watchlist.
- Your iPhone is acting up – you are not even thinking about upgrading to a different handset, it MUST be the latest iPhone (it also links to your Apple Watch and Macbook). Add Apple to your watchlist.
- You recently switched insurance providers – and you cannot be more impressed with the green and purple. Add OUTsurance to your watchlist.
It is not to say that every company you know will be a good investment – but it is a good starting point to build your research from. You can also use ‘invest in what you know’ to eliminate certain stocks from your watchlist or perhaps sell them if you are already invested. Cancelled your DSTV subscription? Maybe others are doing the same and now may not be the best time to invest in MultiChoice.
2. Beware of the ‘next big thing’
There is almost never anything hot about a hot tip. In fact, by the time the average investor gets tipped on a stock by their brother/dentist/hairstylist, the smart money has already come and gone. The next big thing has probably already been bid far beyond fair value and could even be in bubble territory if everyone is talking about it. You may feel like you are missing out at first, but you will more often than not be very happy that you did not get swept up in the euphoria. Good examples here are the Bitcoin and GameStop rallies in 2021.
3. Price matters – it comes down to the fundamentals
Once you have identified stocks you would like to invest in or if you want to check if that hot tip is really that hot, it is important to check if the company is in good financial standing and if the stock price is not too high. While company analysis can get very complex – there are a few things you can check to find comfort in the investment:
- Revenue: Is revenue growing and is there a fair chance that the company will be able to grow revenue in the future?
- Profitability: Is the company profitable – in other words are its expenses less than its revenue? Here you can also look at margins (profits as a percentage of revenue) – are they improving or deteriorating?
- Cash flow: Do profits translate into cashflow? A good measure here is to look at Ebitda compared to cash flow from operations – they should match up.
- Debt: Does the company have a lot of debt relative to its size? Professional investors often look at the net debt figure (borrowings less cash) and consider the “net debt to equity” and “net debt to Ebitda” ratios to determine the financial health of the company. For reference you can look at what competitor balance sheets look like.
- Valuation: While not a perfect science – a company’s PE ratio (price-to-earnings) or PB (price-to-book) ratio can give you insight into how a company is currently being valued. If the PE or PB is higher than normal than it could mean the company is expensive or vice versa.
4. Try not to get emotionally involved
Humans are inevitably governed by their emotions, and it becomes an even bigger issue when we are dealing with money. There is an entire academic field of research dedicated to investor biases (including the emotional kind) known as behavioural science. Some emotional biases in investing include loss aversion (keeping poor performing stocks in your portfolio, waiting for a comeback), overconfidence bias (taking unnecessary risk and disregarding new information), and regret aversion (which goes hand-in-hand with FOMO). Knowing that these biases exist and that you more than likely exhibit some of them is the first step in righting the mistakes we make and avoiding similar wrong turns in future. Other strategies include ruthlessly sticking to your strategy and conducting proper research on what you want to buy and what you hold (to make good selling decisions).
5. Decide beforehand how long you want to stay invested
If you are investing for the long term, it is important to not look too closely at day-to-day movements in the price of your investment. Equities are volatile in nature and by following the price of your stocks too closely – you could get overwhelmed and nervous (PANIC!) and make an incorrect investment decision without conducting your due diligence. It is an entirely different kettle of fish if you are investing on a “technical basis” – in this case it makes our next point even more important.
6. Decide when and why you would sell
If you are trading for short-term gains, it is vital to have a “stop-loss” level in place that will result in the automatic sale of the stock should the share price fall by a certain margin. This can help protect you from taking big losses when the technicals fade or something major happens that is fundamental to the sustainability of the business. You must also have a “profit target” in place and stick ruthlessly to your initial assessment to avoid losing out on your hard-fought gains. If you are investing for the long term, you still need to have an exit strategy in place. While you won’t necessarily have a “profit target” or “stop-loss” in place, you need to decide in what set of circumstances you would sell the investment. It could be that during your regular review of your holdings you find that the fundamentals have deteriorated, or you have identified other opportunities that potentially offer more upside. Don’t hold the stock simply because it has done well for you in the past.
7. Contribute to your trading account regularly and build up a small cash balance
Like what you would do for retirement savings or your TFSA (tax-free savings account), having a regular debit order run to your stockbroking account is a good way to make sure that you are consistently building your portfolio. The opportunities may not be there immediately, but it is always good to have some cash available in your trading account to deploy when they arrive. Having cash in your trading account will also force you to reassess your holdings and allocate more funds where the prospects are solid or build up your cash balance further when you take profits or cut losses following that reassessment.
8. Diversify (but no need to overdo it)
Don’t put all your eggs in one basket is one of the most important investment principles to follow for professional and retail investors alike. By diversifying your holdings across several companies, sectors, and geographies, you can reduce your portfolio risk dramatically. For instance, if your investment in one company performs poorly because of boardroom shenanigans, this will not impact your other stock with a different management team. The benefit of diversification begins to fade, however, when you invest in too many stocks and your portfolio begins behaving like a market ETF. Most experts recommend that a portfolio has at least 20 stocks and no more than 30 to get a good balance of managing risk without sacrificing return unnecessarily.
Chantal Marx is investment research head at FNB Wealth & Investments.
