Stock market investing has been around for many decades, and many financial advisors will agree that investors with a long-time horizon should consider investing in stocks. However, despite the attractiveness of investing in stocks, and the significant amount of information available online, many investors do not get the idea behind investing in stocks clearly. In this article, we will look at what stock market investing is, and will further discuss the benefits associated with investing in stocks.
Stocks (equities) have outperformed other asset classes significantly
An investor who is nervous about investing in stocks should look no further than the historical returns provided by equity markets.
Historical returns of equities VS bond and bills internationally (1990-2017)
(Source – Finalytiq)
On a global basis, equity markets have easily outperformed fixed income assets over the last couple of decades. However, many investors view the short-term fluctuations associated with equity markets a negative feature of investing in stocks. In reality, these fluctuations provide great investment opportunities for long-term oriented investors. Historically, legendary investors including Warren Buffett have shown a liking to invest in stocks when things are looking bad for the economy, and these investments have provided multi-bagger returns to these legendary investors.
Investing in stocks early is the best possible way to accumulate wealth in the long-term, and numbers prove this.
A stock is a piece of a company
One of the primary mistakes of novice investors is treating stocks as a piece of trading security. In reality, buying a stock is an investment made in the underlying company, and any investor who invests in stocks of a company becomes an owner of that company. Understanding this relationship between a stock and its issuing company is an important step in becoming a successful investor. Even though the stock price of a company could be affected by various factors in the short-term, in the long-term, stock prices will follow the earnings of the underlying company. As such, it is important to identify and analyze the future earnings potential of the company issuing the stock when thinking about buying a stock.
(Source – Fiby Design)
An investor should treat investing in stocks the same way as investing in a real world company, and this could do wonders to the performance of an investor’s stock portfolio.
A good company is not always a good investment
One of the biggest mistakes committed by young investors is investing in the companies they know and love in hopes that these companies will provide attractive investment returns. In finance, we call this a behavioral bias. For example, a young investor who loves Apple products might think that Apple is a great investment as many people around the globe including him like Apple products and continue to stick to Apple products. Understanding the difference between a good company and a good investment is vital to building a high-performing equity portfolio.
In order for a stock investment to yield attractive returns in the future, 2 conditions should be met.
- The company should continue to perform well financially.
- Shares of the company should be bought at an undervalued level.
The second point is equally important to identifying a company that performs and is expected to perform well from a financial perspective. Even though Apple is a great company, if Apple shares are trading significantly higher to its intrinsic value, share price might come down drastically in the future, leading to financial losses for investors. Therefore, it’s important to understand that investing in a stock at an attractive price is very important, and identifying a good company is simply not enough to become a successful investor.
Stock market investing is for the long-term
Modern day investors often dream of becoming millionaires overnight, which could eventually lead to massive financial losses. Despite several stories of “traders” who make a living by trading stocks on a daily basis, stock market investing is for the long-term. As highlighted earlier in this article, investing in a stock of a company is equivalent to investing in the company issuing the stock. In order to benefit financially from the expected growth of a company, an investor should keep invested in the company for a long period of time.
To put this into perspective, we can look at the historical share price of Amazon. Amazon shares were trading at a mere $1.73 in May, 1997. An early investor could have doubled his money within a few years and disposed of Amazon shares and patted himself on the back for investing in Amazon at the right time.
However, such an investor would find it difficult to fathom today the opportunity cost of selling Amazon shares earlier than he should have. Today, Amazon shares are trading at a staggering $1917, which could have made millions of dollars to investors who invested in Amazon early and held on to their investments.
Amazon share price movement
(Source – Google)
Information is key
When it comes to investing in stocks, the more you know about the company the better. Having a high level of understanding of the business operations of the company, management decision making process, and future growth expectations, will form the backdrop for a good investment. Therefore, investors should try to understand the dynamics driving the business decisions of a company before investing in shares of the company.
There are many resources available for investors to collect information regarding public listed companies in the U.S.
- Annual reports (Referred to as form 10-K and can be accessed on the SEC website)
- Quarterly reports (Referred to as form 10-Q and can be accessed on the SEC website)
- Earnings conference calls (can be accessed via Seeking Alpha website)
- Free-to-use websites such as Yahoo Finance, MSN Finance, and Morningstar
- Paid subscriptions including Bloomberg, Morningstar Premium, FactSet, and Capital IQ
Stock market investing is one of the best ways to accumulate wealth in the long-run, and no other asset class has provided better returns than equities in the long-term. Investing early in stocks could lead to massive returns for investors, but there are a few misconceptions regarding investing in stocks. In this article, we provided an introduction to stock market investing and a few steps to become a better investor.