There are lot of curious people in this world who want to invest in stock market. But their interest fades as answers to their queries remain unanswered.
I have gathered some frequently asked queries of beginners related to stock investing through my blog. Readers of my blog often ask question in my blog on topic of stock investing. I have accumulated all those queries and decided to post a blog on top 6 queries received from my readers.
The idea of this blog post is to give beginners a brief explanation on their stock investing queries.
So let us see the common stock investing queries of beginners.
#1. For a lay man, making money in stock market is possible or it is just a hoax?
In last 19 years, BSE500 index performance has been shown in the below chart. I downloaded the historic data of BSE500 index from bseindia.com. Total annualized return of BSE500 index in last 19 years is 11.01% per annum.
Average return of 11.01% for such extended period of time (19 years) can be termed as fantastic. But such high returns comes with its share of risk.
You can see the fluctuation that BSE500 index had witnessed in reaching the level of 13,028 (year 2017) from level of 1791 (year 1999).
These short term fluctuations are very unpredictable. It will not be wrong to say that these short term fluctuations cannot be controlled.
The problem with short term fluctuations pose major threat for common men like us. The reason being, we enter stock market only for short periods. Majority buy stocks today with target of selling them in next few months. This is a problem.
Stock market is not a place where we can play like gambling. The predictability of stock market in short term is nearly zero.
But the same stock market displays a perfect growth pattern in long term. See the below chart. Consider any period between 7-10 years horizon. You will see that, between such extended time horizons, stock market has only grown.
Consider the case between year 2007 and 2011. In this period, BSE500 index fell from 8,592 to 5,779. This is fall of ~33% in a span of 4 years.
Any investor who would have invested in stock market between 2007-2008, would have seen only negative gains.
But post 2011, BSE500 index has only shoot up. This is one benefit of staying invested in stock market during market dips.
So for a lay man, making money in stock market is possible if holding time is long term (above 7 years minimum).
#2. How a beginner can check the financial health of stock?
To check the financial health of a stock, a beginner must take the following two steps.
Step 1. Check if the underlying business of stock has strong fundamentals.
The only way to check business fundamentals of stock is to look into companies financial reports. The parameter which are essential to check is cash flow, profits, sales turnover, profitability etc.
I have already written a blog post on this topic in the past. I will suggest you to read this blog post for more details.
Step 2. Check if the market price of stock is undervalued or overvalued
In order to check market price valuation of stocks, one can estimate its intrinsic value. I have prepared a small worksheet which helps in learning stock analysis. Intrinsic value of stocks can be obtained like this. Alternatively one can also look into ratios like P/E Ratio, Dividend yield, P/B ratio, PEG ratio etc to understand if stock in undervalued or overvalued.
You can read one of my blog post on this post to get more details.
#3. From where one can get information on stocks for free
These days there are plenty of stock information available on internet for free. In India the most popular of all is moneycontrol.
But apart from moneycontrol, yahoo finance also provides data which is very well formatted.
Morningstar, Google finance, investing.com are other web portals that provides stock data absolutely free of cost.
I have also used financial tools offered by online stock brokers. I found them to be very helpful as well. Service providers like HDFC Securities, ICICI Direct, AXIS Direct etc.
#3. One must buy stocks for capital appreciation or dividend income?
Investing for dividend income can eventually ensure long term capital appreciation.
Lot of people ask this question in my blog. Investing in stocks for dividend income is very tempting. But the problem with dividends is that, dividend yield of good stocks is too low.
It is not uncommon to find stocks which is yielding dividends in rage of 0.5 to 1.5% per annum.
For sure, people who enters stock market can never be satisfied by such low returns.
But for me dividend paying stocks are number one choice. It is a fact that I love the concept of dividend (passive income). But more than that, dividend is a great yardstick for me as a stock investor. Lets see how…
As an investor our prime focus is to buy fundamentally strong stocks at undervalued price levels. Dividend is a great yardstick via which we can identify if a particular stocks is a good buy or not.
But looking only at dividend yield is enough?
Dividend yield is a great indicator, but in isolation, dividend yield is not so reliable.
Little bit detailed analysis of dividend that companies pay to its shareholders, helps is picking quality stocks which ultimately ensures capital appreciation in long term.
So lets see how to do detail analysis of dividend. Open companies profit and loss accounts and note down its EPS history and dividend per share history for last 10 years.
Dividend per share divided by EPS is called dividend payout. Check if the dividend payout history for the company has been consistent or not. Ideally companies keeps their dividend payout constant.
Too must fluctuating dividend payout (specially down sides) makes the stock less reliable.
Once dividend payout history has been evaluated, one must check the dividend per share growth rate. Evaluate at what CAGR (growth rate) dividend per share paid to shareholders has been increasing in last 10 years. If dividend per share growth is growing at rate close to inflation, that stocks becomes very interesting.
Finally one must look into the dividend yield. First calculate the dividend yield by noting down dividend per share paid in last year (dividend/share divided by current market price). Suppose the dividend yield comes out is 5.5% (D1Y).
In the next step, calculate average dividend/share for last 10 years. Now calculate the dividend yield by dividing average dividend/share by current market price. Suppose the dividend yield comes out to be 1.5% (D10Y).
What does this tell us about the stock? D1Y is as high as 5.5% because the company decided to pay extra dividend to its shareholders last year. Comparing it with D10Y (1.5%) it looks very unlikely the company is going to pay such high dividend again.
On an average, the company pays a dividend with dividend yield of 1.5%.
It is important to be aware of the companies average dividend yield averaged over last 10 years. When market price rises, this dividend yield will fall. When market price falls, the dividend yield will rise.
A stock whose last 10 years average dividend yield is more than 3.5%, it becomes a good buy.
High dividend yielding stocks can be considered undervalued. Hence they can also ensure reasonably capital appreciation in long term.
#4. Preference shares are better or common stocks are better?
Preference shareholders earns regular dividend income. This dividend income can be fixed or variable. But a company is obliged to pay some dividend to its preference shareholders.
Common shareholders are also eligible for dividend income. But companies are not obliged to pay dividend to its common shareholders.
Preference shareholders are obliged to hold stocks for a predefined time period. After the lapse of this period, preference shareholder can sell their stock holding back to the company.
Common shareholders are not obliged to hold their stocks. They can buy today and sell it tomorrow.
Hence common stockholders are able to book profits more easily as compared to preference shareholders.
In a worst case scenario, suppose the company goes bankrupt. In this case the assets of the companies are liquidated for cash. This cash is then used to pay off companies liabilities. Once all the liabilities are paid, preference shareholders get their share from balance available cash. Common stockholders stands after preference shareholders in the priority list
#5. How must return one can earn from stock market
In India, on an average, a fundamentally strong stocks bought at undervalued price values can give returns close to 15-16% per annum.
But generally fundamentally strong stocks are rarely available at undervalued price levels. It means, most of the time we, we end up buying stocks at overvalued price levels.
In such a scenarios, data prove that, an average return of 7-8% per annum is only possible.
To understand how must return a stock can provided in long term, check its EPS growth rate (10 years) and Net worth growth rate (10 years). A company is most likely to give returns close to their EPS & net worth growth rates. But this will possible only when stock is bought at undervalued price levels (PEG ration less than 1).
#6. How to invest in stocks without taking lot of risks?
If you have read this far down, I could assume that by now you must be already feeling little but anxious about stock investing. Stock are risky and buying good stocks is also not so easy.
So what is the alternative? A common man should stay away from stocks investing?
Not at all. There are some avenues open for common men to invest in stocks indirectly.
The closest alternative to direct stock investing is Exchange traded funds (ETF). One can buy and sell ETF from open market just like stocks. ETF’s are provides the advantage of investment diversification like mutual funds and easy of trading like stocks.
The other best alternative of stocks investing is to buy units of diversified equity mutual funds. If mutual fund units purchase is done through SIP, it is even better.
Apart from this, index funds are also great way to invest indirectly in stocks.