How does a beginner investor seek and evaluate markets and companies worth investing in?
I'm a beginning investor. I'm struggling in learning how to research markets and companies to invest in. What are key indicators to look for and use as a guide? How do I find companies that offer dividends on stocks?
Believe it or not, the “For Dummies” series actually offers two pretty good resources for brand new investors: "Investing For Dummies" and "Stock Investing For Dummies." Both are accessible to new comers, extremely readable, and provide a decent foundation of knowledge. In fact, I even recommend that folks who want to hire a professional to do their investing for them read these books if they have no other base of knowledge, just so they have some common points of reference.
If you burn through those and are yearning for more, I would recommend Benjamin Graham’s "Intelligent Investor." This book is not necessarily advanced, but it is certainly not as readable as the For Dummies books. It spells out some important concepts about the nature of investing, as well as time tested pointers about choosing investments.
If you want to begin to apply your newfound knowledge by utilizing some tools of the trade, most of the online brokerage houses now provide some really neat research functions. This is true even if you’re starting out with a small account size.
Many of the included research tools provided by online brokers now allow retail investors to perform multiple filters to scan through thousands of securities and strain out the few that meet a stated criteria. But first, of course, you have to at least know what you’re filtering for, which is where the previously mentioned resources might come in handy.
I will go ahead and throw in the typical warning, though, that investing in theory and in practice can sometimes be two very different animals, especially at the start. So, if you’re truly just starting out, I would recommend that you take it slow at first, and, if you’re fortunate enough to have some early successes, don’t let it go to your head. One of the best teachers is experience, so it’s valuable to get hands on. However, the cost of tuition for experiential education in investing can sometimes be inordinately high.
At the risk of throwing cold water on your plan, there are many good reasons not to do research on individual stocks.
- As a beginning investor, you probably do not have enough money to buy enough individual stocks to be truly diversified. Portfolios concentrated in just a few stocks are far riskier than broadly diversified portfolios, but do not compensate you for this added risk in the form of a higher expected return.
- You have no source of competitive advantage in researching individual stocks. The world is full of professional investors who, in theory, have a big advantage over you, given their training and resources. As I’ll explain in a minute, even they may have little or no advantage.
- In his work, “The Arithmetic of Active Management” (http://www.cfapubs.org/doi/pdf/10.2469/faj.v47.n1.7), Nobel Prize winning economist William Sharpe elegantly explains why active managers (which is what you seek to become) as a group perform in line with an index (for example, the S&P 500), and why collectively they do worse than an index when expenses are taken into account. For you to do better than an index requires that some other active manager do worse. All things considered, the odds are stacked against you.
- Efficient Market Hypothesis (EMH) suggests that even the active managers who beat the index in a given period are no more likely than any other manager to beat it in the next period. EMH may not perfectly describe financial markets, but for the kind of stocks you’re likely to research, it’s probably a pretty close approximation. Again, the odds are not in your favor.
- Researching and monitoring individual stocks takes time and resources that you could probably more profitably devote elsewhere, particularly to something you’re already skilled at.
You will be best served putting your hard-earned savings (that portion you earmark for the stock market) into a stock index mutual fund, such as an S&P 500 index fund or a total world stock market index fund. In such funds, you will very closely track the market as a whole. And because you will do so at very low cost, you will outperform the majority of active managers. All that, without knowing the first thing about how to research individual companies and stocks!
One caveat – if you really enjoy researching individual stocks, that’s fine, but realize that it is a hobby and a form of entertainment, not a sound long-term investment strategy. I recommend restricting such individual stock investments to not more than 5% of your liquid assets.
You are asking a good question as nobody starts out as an experienced investor so you have to start somewhere. Markets are different than individual companies. Mature markets are places like the United States, Canada, England, Australia, France, Germany or countries where one can have some level of confidence in the rule of law. You can monitor country markets by their indexes, which are a group of companies which are listed in that country, often times having their corporate headquarters there (where they incorporated). These are typically the most powerful and financially successful companies in this country. For example, in the United States, think about the Dow Jones Industrial Average or the S&P 500 or Nasdaq. In England, they have the FTSE Index. You can look at any country and research their index to find out what stock index it is and how you can potentially have a small ownership piece of each of the companies in the index. Regarding specific companies to invest in, and what indicators to look for and use as a guide, this is another good question where there is quite a bit involved to consider. On any individual company, you probably need to research the history of the company, its management team and board of directors, the business it is in, and become familiar with its specific market and current competititon and how it compares. You would look at its financial statements and filed government documents like the annual report and 10-q filings to get its most recent financial results. You also would look at its 1, 5, and 10 year stock performance to see what kind of returns you would have gotten if you had invested in the stock. As far as key indicators, you might read up on Price to Earnings, Price to Sales, Price to Cash Flow, and Market Capitalizations and Enterprise Value to get a basic understanding of how stocks are evaluated through fundamental anaysis. My own opinion is to forget anything related to charting as far as analyzing individual companies. Regarding finding stocks with dividends, you will look for companies that have a history of paying dividends for the last 5, 10, 20, or even 50 years. There are plenty out there, and a good place to look is in the S&P 500 index with companies like Johnson & Johnson, Exxon Mobil, 3M, McDonalds, Proctor & Gamble, Pfizer, JP Morgan Chase, etc. I hope this helped answer your question on researching markets and companies to invest in. Also, investing in individual companies and markets is a great way to learn about all kinds of industries and interesting situations which you can use in other parts of your life.
Yale Bock, CFA
Y H & C Investments
Hi! Thanks for writing! Great advice from our other advisors. I wanted to add one more place to do research and learn - it's free and unbiased: www.investor.gov. They describe themselves in this way: "Brought to you by the SEC’s Office of Investor Education and Advocacy, Investor.gov is your online resource to help you make sound investment decisions and avoid fraud." Of course, all of us writing on Investopedia and working as financial advisors LOVE this stuff, and if you do too, it's great to learn as much as you can. Enjoy yourself with this!
Thanks for the question! If you are just starting out as an investor, it can't hurt to educate yourself on the markets by reading about investing strategies in general, and perhaps about specific companies in particular. However, when it comes to putting your money where your mouth is and actually making an investment, I would encourage you to consider leveraging the expertise of a financial advisor, an investment manager, or some other professional to help you navigate what can be a confusing and overwhelming landscape of investment opportunities.
However, in all honesty, the vast majority of investors are best served by investing in low-cost, passive index funds - Vanguard has a number of excellent options. Investing money into an index, rather than into a specific stock that you may not fully understand, provides the dual benefit of diversification and broad-market exposure. Vanguard even has funds that are comprised of numerous underlying indexes, both equities and fixed income, to give investors diversification and broad-market exposure across the capital spectrum. For example, Vanguard LifeStrategy Growth Fund (VASGX) is made up of 80% equity indexes, and 20% fixed income indexes. With an annual fund expense of 0.15% (versus 0.84% for the industry average), VASGX is one example of an inexpensive way for an investor to diversify across equity and fixed income markets via a single fund. Also, with a current yield of 2.09%, VASGX also provides annual cash flow to investors.
Hopefully this helps - please let me know if any questions!
Bingham C. Jamison, CFA