DIFFERENT TYPES OF COMPANY STOCKS

Over the years, stocks have proved their worth and deserve a prominent place in any long-term investment plan, such as a retirement account. Since the year of 1926, stocks have beaten the performance of any other major asset class by a wide margin that has a return nearly 10% per year on average. Due to the fact that stocks by their nature are volatile, their value rises and falls to invest in them requires great cautions, thus, they should ideally be held to meet medium- and long-term goals. In other words, money invested in stocks should not be the money that you might need in three to five years. Nonetheless, stocks tend to deliver handsome returns in the long run, but volatile markets may not cooperate with your short-term cash needs.

 

1. GROWTH STOCKS

Growth stocks are the shares of companies with the potential to consistently generate above-average revenues and profit growth. These companies tend to reinvest most or all of their earnings in their businesses and pay out little or none of their profits to shareholders in the form of dividends. Owing to the fact that growth companies expand faster than the overall economy, hence, you can occasionally find these companies in mature industries. After all, keep in mind that even fast-growing companies are not necessarily good investments if their shares appear to be overvalued.

 

2. CYCLICAL STOCKS

Cyclical stocks are the shares of companies whose sales and earnings are highly sensitive to the ups and downs of the economy. When the economy is performing well, for instance, cyclical companies tend to shine. A contracting economy typically hammers the sales and profits of these companies and hurts their stocks. Whatever it is, cyclical industries include manufacturers of steel, automobiles and chemicals, airlines and homebuilders.

3. DEFENSIVE STOCKS

Defensive stocks describe the shares of companies whose sales of goods and services tend to hold up well even during the economic downturn. Some of the examples of industries that are substantially isolated from the business cycle are utilities, government contractors and producers of basic consumer products such as food, beverages and pharmaceuticals.

 

4. INCOME STOCKS

Income stocks typically pay out a relatively high ratio of their earnings in the form of dividends. The companies that issue them tend to be mature and have limited chances for reinvesting their profits into more attractive opportunities, for example, the utilities providers. In short, stocks that pay large dividends are usually less volatile because investors regularly receive cash dividends regardless of the market cycles.

5. SMALL-COMPANY STOCKS

Small company stocks have generated better returns over time than stocks of large companies. Although these companies tend to grow faster than their larger brethren, however, there is a trade-off - "small company stocks are much more volatile than the shares of big companies". Perhaps, there are a number of ways of defining what constitutes a small company. One common example or definition is that a small company is usually the one with a stock-market capitalization of $1 billion or less (if you have no clue what market capitalization is about, it is basically a company’s stock price multiplied by the number of shares outstanding).

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LEARNING HOW TO READ A COMPANY’S FINANCIAL STATEMENTS

Before you decide whether or not if you should invest in stock market, here are a few questions that would help you make a better decision and push you to think very carefully.

- How much cash does the company already have?

- How much revenue has the company made since it was started?

- How much revenue does the company expect to make in the future?

- Does the company have any debts?

Then, once you have done asking yourself with the above questions, the next step for you to start is by looking at the company’s financial statements. Learning how to read Financial Statements is similar to learning a new language. If you want to order a better dish in a Spanish restaurant, you will probably need to speak Spanish to read the course of menu. This is similar with a company’s business. If you want to find a good stock to invest in, you will need to learn how to speak the language of finance and read their financial statements. Just like learning any new languages other than your mother tongue. It is difficult at first, yet, the more you practice the more fluent you will become.

Broadly speaking, all companies need to keep track of their finance which means that they are keeping track of all the money coming in and going out, as well as other transactions that do not necessarily involve the exchange of money. At the end of each month, quarterly (three months), and year, a company will prepare financial statements which literally are the summary of all its financial transactions in that given period. In the case of a company that is publicly traded where its shares are sold on a stock market, for instance, it is required that the company prepare and file quarterly and annual financial statements so that the government and the public can see how the company is doing.

Actually, there are a lot of parties who will be keen to have a look at the financial statements of a company. First, the company’s management and board of directors will use the financial statements to track performance. The financial statements typically show how the company has done in the past and will help management to make better decisions about the future. Second, Lenders or the so-called creditors such as banks that have provided loans to the company may also want to see its financial statements. Some loans may have certain requirements, such as the company’s debt-to-equity ratio "cannot be more than either 0.3 or 0.4" in order to receive that loan, or the lender may just want to see how much cash the company has in order to estimate how likely it is the company will be able to pay back the loan and interest in a timely manner.

Here’s a quick illustration of a company’s debt-to-equity ratio, and how to calculate it is by "dividing a company's total liabilities with its shareholders’ equity".

On the other hand, investors are very interested in seeing the financial statements. They are making decisions about whether to buy or sell stock in the company and thus they need to know how the company is doing to help inform their decisions. When it comes to a company’s financial statements, there are three types that you need to learn how to read them before you decide to invest or buy its shares.

Firstly, it is a balance sheet. The balance sheet basically shows a snapshot of the company’s assets (its resources that it expects to create value in the future), liabilities (the loans and other obligations due to others), and owners’ equity (also known as shareholders’ equity or stockholders’ equity – the stake that the owners or investors like yourself have in the business).

Secondly, it is an income statement. The income statement practically demonstrates how much revenue the company generated over the year, how much it cost to sell its main products, how much it cost to pay its employees over the year, and how much it owed in interest and taxes for the year. On a very basic level, if the company makes more revenue than it spends in costs, it is a profitable business. However, if the company’s costs are greater than its revenues, then it is not a profitable business.

Thirdly, it is a statement of cash flows. The statement of cash flows technically illustrates how much cash came into the business and how much cash went out of the business. It is important to note here that when we use the term cash in the financial world, we mean not only the currency bills like you normally think of such as dollars or euros, but also checks, electronic transfers, as well as the balance in the bank account. In fact, most businesses will do a lot of their transactions through electronic means (e.g. mobile banking, wire transfers, etc.); yet, they are still considered as the amount of cash which flows in and flows out.

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UNDERSTANDING THE STOCK MARKET'S TERMINOLOGY: MARKET CAPITALIZATION AND PRICE-TO-EARNINGS (P/E) RATIO

Basically, a company’s worth its total value in the stock market is called "Market Capitalization" and it is represented by its stock price. To put it in a simple term, Market Cap (Market Capitalization) is equivalent to the stock price multiplied by the number of shares outstanding or being traded.

For example, a stock with a $5 stock price and 10 million shares outstanding/being traded is worth $50 million ($5 x 10 million). If we take this one step further, we can see that if a company that has a $10 stock price and one million shares outstanding (the market cap = $10 million), then the company is worth less than the one with a $5 stock price and 10 million shares outstanding (market cap = $50 million). Thus, the stock price is a relative and proportional value of a company’s worth and only represents percentage changes in market cap at any given point in time. However, any percentage changes in a stock price will result in an equal percentage change in a company’s value. This is the reason why investors are so concerned with stock prices and any changes that may occur even if it is just a $0.10 drop in a $5 stock can result in a $100,000 loss for shareholders with one million shares.

Aside from market capitalization, one way to determine the value of a company’s business is with the Price-to-Earnings Ratio or the so-called "P/E" Ratio. The price-earnings ratio (P/E) can be calculated as "Market Value per Share (Stock Price) / Earnings per Share". For example, let’s say that a company is currently trading at $43 a share and its earnings over the last 12 months were $1.95 per share. The P/E ratio for the stock could then be calculated as $43/$1.95 (Stock Price / Earnings per Share) or about 22x (22 times). In essence, the price-earnings ratio indicates how many years an investor has to wait at the current earnings to get all their money back. If the P/E ratio is 22x, it will take you 22 years for the company to earn how much you bought the stock for $43. In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to the ones with a lower P/E. And a low P/E can indicate either a company may currently be undervalued or the company’s profits are expected to decline.

Perhaps, there are some rules of thumb when you think of the P/E (Price-to-Earnings) Ratio as the price you pay for a stock:

1. The average P/E over the past decade is 15x. An average company should be worth about 15x.

2. The typical great companies with very high returns and consistent earnings growth tend to trade about 20-25x P/E, while bad companies or the ones whose earnings are unpredictable and make low returns usually trade at below 10x P/E.

3. A company should trade at about the P/E as its earnings are expected to grow in the future. For example, companies with growing profits 30% per year may be justified to trade at 30x P/E while the ones with not growing may trade at 5-10x P/E.

Overall, below here is a quick chart to measure what P/E Ratio should be so that you will have a better understanding of the above rules of thumb which has already been explained.

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THE SEVEN GOLDEN RULES OF SUCCESSFUL INVESTING

Being successful at anything requires following a set of rules. Good rules are the accumulation of decades of wisdom summed up into the few components that really matter. Successful football players, given as an example, win because they avoid penalties and because of the way they undergo a series of rigorous training. This is similar to academic learners. Successful students get A’s because of the way they study. The point is that investing in the stock market is no different except that when you succeed in investing, you make a lot of money.

 

RULE NUMBER 1 – THINK LONG TERM

Trying to time the stock market or risking it all to double your money in a year is at best speculating which is similar to the worst gambling. You may as well just take your money to Vegas and lose it there. However, those who are able to successfully navigate the stock market are not speculators or gamblers, but they are investors. Needless to say, they know they can beat the market because they think differently, they think smarter, and they think in a longer-term period.

 

RULE NUMBER 2 – GOOD COMPANIES MAKE GOOD INVESTMENTS

People need to understand and keep in their mind that investing is not like placing a bet on whether the Cowboys will cover the spread against the Packers in the big game. Investing is not trying to get the quarterly press release a microsecond before the other person. It is not even about trying to predict which stock that you think will go up the most. Fundamental Investing is all about buying a tangible piece of a business, or a share of that business. What’s more, your investment portfolio (the collection of all the different shares you own) is only as good as sum of the companies in that portfolio.

If you buy shares of high quality companies at reasonable prices, you will end up with a high quality portfolio with less risk. And good companies are the ones which have a unique advantage that others may not be able to imitate. They are simply the ones which generate high returns on capital, as they do not need to borrow a lot because their business is self-financing.

 

RULE NUMBER 3 – BUY WITH A MARGIN OF SAFETY

When it comes to investing, a margin of safety is formed when one buys an investment at less than its value while using conservative assumptions. The idea of a margin of safety is that you want to buy a business at a price that is low enough with consideration that your assessment could be completely wrong and therefore you would not lose that much.

RULE NUMBER 4 – DO YOUR OWN HOMEWORK AND KNOW WHAT YOU OWN

There is no substitute for your own work. You wish to buy a stock because CNBC recommends it, or because your uncle suggests it or perhaps the stock chart on your laptop screen looks good enough to convince you. Well, the truth is that all of these are a sure way to lose your money. Successful investors, in case if you are wondering, know exactly what they own. They buy stocks of companies with products they believe in. Not only that, but successful investors go the extra mile to analyze the financials of the companies’ stocks they own in order to make sure they are not missing anything. Remember, most of the extraordinary gains made in the stock market come after a stock is punished, or after it has already risen a lot but you are not going to have the conviction to stick with it unless you really know exactly the companies’ shares that you put your eyes on.

 

RULE NUMBER 5 – STAY CALM AND BE RATIONAL

The typical buyer’s decision is usually and heavily influenced by those around him, which is to buy when others are buying, and to sell when others are selling. Unfortunately, this is a recipe that is bound to backfire. The best investors are the ones who can fight this urge and remain calm through a storm on the sidelines of a market bubble.

RULE NUMBER 6 – DO NOT PUT ALL YOUR EGGS IN ONE BASKET, BUT YOU DO NOT NEED TO HAVE TOO MANY BASKETS EITHER

Diversification is one of the most critical business strategies for your portfolio so that if one stock blows up, it will not sink the entire ship. As much as you think that you will not make a mistake, you will do just fine. Even the masters do and that is why you are highly advised to not put all your eggs in one basket. When it comes to having diversification, research suggests that 90% of diversification benefits can be obtained in most markets with a portfolio of just over 20 stocks. In other words, the more you diversify beyond that, the less you know about each investment you make. After all, your first and second best ideas are always better than your 100^th best idea so while diversifying is crucial, make your best ideas count!

RULE NUMBER 7 – NEVER STOP LEARNING!

Perhaps the most important rule is to learn more and then keep learning. The fun thing about investing is that the markets are always different and companies are constantly changing. Hence, never stop learning about businesses, never stop learning from other great investors, and never stop learning from your own mistakes. Humility and an eagerness to learn are two traits found in all of the great investors. Even the world’s greatest investor "Warren Buffett" credits his partner Charlie Munger by teaching him that it is better to buy a great company at a fair price than a fair company at a great price.

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INTRODUCTION TO THE STOCK MARKET

Investing in the stock market can be fearsome, especially during the beginner’s phase because of the complexity and the risks involved in the market. By definition, the stock market refers to public markets that exist for "issuing, buying, and selling stocks" that trade on a stock exchange or over the counter – a place where investors can buy and sell ownership of such investable assets. Stocks or also known as equities, in addition, represent fractional ownership in a company and the stock market serves two important purposes behind its establishment:

1. First, it is to provide capital to companies that are listed in the stock market so that they can use it to fund and expand their businesses. For example, if a company issues one million shares of stock that initially sell for $10 per share, then that provides the company with $10 million of capital which can be used to grow its business.

2. Second, it is to render investors (people who purchase and own stocks) the opportunity to share in the profits of publicly-traded companies. For example, if an investor buys shares of a company’s stock at $10 per share and the price of the stock subsequently increase to $15 per share, the investor can then realize a 50% profit on their investment by selling their shares.

To kick things off, a stock or also known as equity is a security that represents the ownership of a fraction of a corporation This, in theory, entitles the owner of the stock to a proportion of the corporation's assets as well as profits equal to how much stock they own, and the units of stock are called "shares". When it comes to the technicality procedure of buying and selling stocks, one must go through brokers who are authorized to trade on the market or stock brokerage companies that allow you to trade using their platform. Hence, here’s the simple process of how to invest in the stock market:

1. To begin investing, you must open a trading account with a broker or a stock brokerage platform (in this case, the securities company). And, a trading account that you must open is basically where you execute your "trading" – a place for you to buy or sell orders.

2. The broker or the stock brokerage platform (in this case, the securities company), subsequently, opens another account for you aside from your trading account which holds the financial securities in your name. As these two accounts are then linked to your bank account, you need to provide the Know Your Customer (KYC) documentation that includes verification via government-authorized identity cards.

3. Most brokers and brokerage platforms, nowadays, have an online KYC process that allows you to open an account in a couple of days by submitting your verification details on a digital basis. Once it is opened or registered, you may begin your trading with your broker or brokerage company via online or phone calls.

Furthermore, the concept behind how the stock market works is actually quite simple. You probably have heard of the New York Stock Exchange. Companies in United States list all the shares of their stocks on the New York Stock Exchange through a process called "IPO – Initial Public Offering". Investors can then buy and sell these stocks among themselves, and the stock exchange tracks the supply and demand of each listed stock. The amount of supply and demand, additionally, helps determine the price for each stock or the levels at which stock market participants (e.g. investors and traders) are willing to buy or sell. At this stage, the buyers offer a "bid" which is the highest amount that they are willing to pay but is usually lower than the amount that the sellers "ask/offer" for in exchange. This difference in the stock market terminology is called the bid-ask spread.

Meanwhile, there are some financial instruments offered by the stock market, such as:

1. Equity shares: They are issued by companies that are listed, and the equity shares entitle you to receive a claim to any profits paid by the company in the form of dividends.

2. Bonds: They are issued by companies or governments and represent loans made by the investor to the issuer. These bonds are issued at a fixed interest rate for a fixed tenure and therefore, they are known as debt instruments or fixed income instruments.

3. Mutual Fund: They are issued and operated by financial institutions and are considered as a vehicle to pool money to be invested in different financial instruments. The amount of profits derived from the investments will then be distributed between the investors in proportion to the number of units, or investments that they hold. At this point, a fund manager takes calls on what to buy and sell on your behalf to generate better returns of the investments you have made.

4. Derivatives: A derivative stems from the value of its performance of an underlying asset or asset class. These derivatives, in fact, can be commodities, currencies, stocks, bonds, market indices and interest rates.

Bottom line, all brokers are paid based on a transaction fee from every trading incurred which includes taxes and dues paid to the government.

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