Firstly, how risky is stock investment?
Despite the KLCI’s limp performance in 2015, there were a few stocks that were not included in the KLCI index which had skyrocketed incredibly. Do you know how much you have missed? Let’s look at how much profit you could have gained if you had picked the top gainer, which was rather unpopular back then:
If you have done enough analysis and bought the shares of this company, you would turn RM10,000 into RM135,200 in just a year.
Impressive enough? However, if you are one of the speculators who might thus think that following the price trend would simply make you a lot of money, take note of this: over-reliance on momentum trading will not take you far. Let’s look at another example here:
Looking at the chart above, you might think that you could earn a huge profit if you enter your bid in mid-December 2014 and wind up everything before January 2015. However, the most likely outcome would be you are too late to buy the stock once you’ve seen this huge opportunity. Moreover, the demand will be sky-high and it might cost you more to own the shares. You might have bought at a price higher than RM0.40 and then sold them at a price lower than RM0.40.
Does that mean chart analysis or technical analysis is not useful? No, but relying on chart and technical analysis is not enough to make yourself a so-called “value investor”. Therefore, knowing some good principles to follow throughout your investing life is crucial. We will show you some principles on how to make a good stock investment.
Understand the macro-environment and micro-environment first
So far, 2015 was a busy and overwhelming year for the Malaysia’s market. The 1MDB scandal, investigation on Prime Minister’s alleged corruption, lower Ringgit currency, GST implementation, possibly a United States interest rate hike during September, China’s market slowdown, weak commodity prices and Trans-Pacific Partnership Agreement (TPPA) altogether shaped the stock market’s situation today.
A market correction (or when the market is down), like what happened, is when the huge opportunities emerge and it is the best time to analyse stocks while waiting for the market to rebound. This is when you need to narrow down your analysis on the micro-environment.
For example, by benefitting from the weak Ringgit back then, there were several industries such as technology, glove manufacturing, furniture, and semiconductors that were doing well in general. When picking the desired sectors, you are encouraged to pick from a few biggest players in the sector. This is because these big players can attract more attention and the trading volume is somehow guaranteed.
“Understand what the company is doing” is overwhelmingly quoted but it means everything
If you happened to be in China back then and you had a chance to ask a random Chinese retail investor about the stock he/she owned, there was a possibility that he/she knew nothing about the stock. The market was so bullish and everything seemed to be positive before the indices plummeted crazily. However, in a true investing world, there is no such thing as “a free treat”.
You will not always be lucky enough to enjoy a high return by randomly picking stocks. The chances are you might get caught up in the market correction. To minimize the chances of buying the wrong stocks, read up on all the useful reports and financial news every day to get a better understanding of the company.
Keep in mind that you should not pick the stocks that are outside your “circle of competence”, meaning that you should not invest in sectors or industries of which you do not have an understanding on how the industry works. Most importantly, you need to know how to explain the business model in a simple way as some businesses can be very complex.
Look for new products/management but beware of overly ambitious management
You will want your company to proactively search for growth opportunities. New products or services are the propellants needed to boost share price if they are made beyond expectations. Eventually, you would love to buy a stock before its price increases tremendously. On top of that, any change in the management could refresh the company’s outlook when the existing management is not doing well in generating revenue growth.
Be careful when the company announces that it is going to expand into a totally new business. Companies may glorify the words (such as diversifying its business/revenue stream) to justify their divergence from its main business with the highest profit margin. Besides, the company may not have enough expertise and manpower to handle the new business. One of the most likely consequences may be the company suffers from lower overall profit margin after the expansion.
Look for the companies with strong balance sheets
Many people tend to overlook or do not understand the importance of a strong balance sheet. Strong balance sheet is essential because it translates the company’s ability to prevent liquidity issues. Intuitively, you would not like to see a highly indebted company which possibly couldn’t repay its creditors.
In a proven way to select a fundamentally good stock, look for current ratio (current assets / current liabilities) > 1.5, cash ratio (cash / current liabilities) > 0.5 and gearing ratio (debt / equity) < 0.5.
Look for Return on Equity (ROE), revenue growth and profit growth at least as high as 15%
Large figures (although quite essential at times) are not the comprehensive reason to invest in a company. Also look for stability and consistency of the growth rate over the past three years. Many average companies manage to record impressive revenue growth but unable to achieve the same growth rate when it comes to earnings. This is where its efficiency is put into question. The ideal case will be the growth rate of revenue equals to the growth rate of earnings.
Knowing when to sell
In many cases when the share price has already dropped more than 10%, people still tend to think that the price will rebound shortly because they believe that the stock is still “undervalued” and the buying volume will recover very soon. The key concern is why an undervalued stock can’t stay undervalued forever?
Remember that value investing is not just about finding the undervalued stocks, it also requires the correct timing and environment. Hence, to prevent yourself constantly suffering from non-performance of an undervalued stock, you should use stop-loss order widely to limit your loss at 10% or any percentage as you please. This will help to limit the loss caused by your mistakes.
Investing in the shares of a public listed company is one of the many ways to make yourself rich, only if you are well-educated with financial knowledge. This is because having the sufficient experiences and skills will make a significant influence on your ultimate profit figure. Amongst all, discipline is the utmost important skill that you’ll need to master throughout your investment journey. Juggling too much with the feelings of greed and fear will somehow make your plans fail.
Stock investing is interesting and in many cases very rewarding but you have to be able to analyse with thoughtful financial knowledge before investing. If you do not know what you’re buying and blindly follow others, it can easily lead you to disaster. By using the principles we have shared with you as a start, get ready to discover more along your investment journey and “stock up” towards your retirement.
If you still prefer to leave it to the professionals, you can learn more about Unit Trusts/Mutual Funds from our Part 1 article.