Learning how to invest in shares is essential for beginners. Shares are inherently risky form of investing money. Beginner who does not know about investing in shares shall proceed carefully. Otherwise risk of loosing what is invested is very high. We all want to earn high returns on investment (ROI), but making high losses is also very probable in shares. If practiced with care, share investing in India can give high returns even to a beginner.
Beginners must consider various alternatives while investing in shares. Alternatives of shares available are debt linked plans, real estate, gold, mutual funds, ETF etc. Selection of the best alternative depends on 3 things : (1) time horizon, (2) risk profile & (3) desired return. If requirement is high returns then the preferred alternative should be shares & equity linked mutual funds.
There is no doubt that equity linked investment gives higher returns. But equity investing (shares, mutual funds) alone cannot guarantee high returns. It is also essential to buy right equity and hold it for long term. What it means by ‘right equity’? Stocks of fundamentally strong companies at right price points at right equity. No matter how perfect is a company, but if we do not give it time to grow, even shares like Apple Inc can give negative returns. As a rule of thumb, one must hold on to purchased shares for a minimum of 4-5 years. Holding period lower than this means we are only speculating.
Investing in Shares calls for Long Term Holding
Opting to invest in shares with long term holding periods is essential. One can link goals with each share purchase. This will make the investment more focused. Suppose one has a financial goal of building wealth for higher education of child.
In order to meet this goal one needs Rs 20 lakhs after 10 years. Every share one buys shall be with the objective of holding it for next 10 years. Though shares are risky but when holding period is as long term 10 years, then returns are more predictable. But why long term returns of shares are high & predictable?
Shares represents stake of shareholders in a company. Shareholders are proportional owners of a company. When more shares are purchased, the proportionate ownership of shareholder also increases. Company uses shareholders money ‘as employed capital’ to operate business. They also use this money to fund their expansion & modernization projects. Execution of these projects helps company to increase its profitability and market share. It takes time (minimum 3 years) for companies to execute projects. This is one reason why shares are only for long term investing.
When profit of company increases it increases its Earning Per Share (EPS). Any change in EPS directly effects market price of shares. If company is able to increase its EPS at rate faster than inflation nothing like it. Generally EPS growth rate in long term horizon surpasses rate of inflation. Long term holding of shares can give protection against inflation. Market price of any product increase compensating rising inflation. The profit of a company will also increase with rising market price. This increase in profit will be reflected in market price of shares. A company which is not able to increase price of its products, beating inflation, it is a bad indicator.
Investing in Shares is Best when Done for Dividends
Profits of company is distributed among shareholders in form of dividends. Distribution of dividends are generally paid once a year. Unlike capital appreciation, dividend payment of large companies are predictable.
Upon share purchase, dividend is like additional income that happens in parallel to capital appreciation. The total gain for shareholders due to shares investment is Dividend Income + Capital Gain. Dividend is a very good value indicator for investors. A company which has distributed dividends consistently in past is most likely continue to do so in future. A loss making company cannot distribute dividends consistently.
So looking at dividend history before buying shares is a very good strategy. Return on investment (ROI) of share is calculated as the difference between purchase and sale price. But investing in shares which also pay dividends will have higher ROI. A stock bought at $50 and sold at $60 means that the profit is at $10 per share (20%). But if dividend of $2 was also paid then profit will be $12 (24%).
Investing in shares is best when done in Large Companies
The larger is the company, the more stable will be its earnings & share price. Large companies has strong working management. Customer & shareholders benefit from the entrepreneurial value creation of large companies.
Beginners must focus on investing in shares of large companies. How stable were the market price of share in the past? Stability of price can be checked by means of charts. On the internet price of shares can be easily be found. Using these charts, long term price trend of shares can be established. Just for example, I have provided here comparison between TCS & SENSEX in form of a chart. The uptrend that TCS has shown compared to Sensex is phenomenal. Sensex itself has appreciated very well since 2008. But TCS graph is even better.
TCS is our example of a ‘Large Company’. Such large companies in India show less volatile price movements. But looking just at price charts is not sufficient. It is equally important to see companies EPS history. A history of companies EPS growth of last 5/10 years establishes if company is really stable and reliable.
Ideally, companies must increase its EPS @ 10% CAGR (more than inflation) every five years. Even if price charts show stable prices but EPS is not growing at desired rate, investing in such share is not worth. In general such large & stable companies are categorized as Blue Chip Stocks. Blue Chip Shares show less price fluctuation. Blue chip stocks are suitable for people who want to take lower risk in shares investing.
Invest in Shares but ignore Short Term Volatility
Despite our liking for shares it cannot be ignored that, in short term, price of shares are very volatile. This is why shares investment is suited for long term investing. Over a period of 7-10 years, short term volatility gets compensated.
We can understand this by looking last SENSEX movements of last 8/10 years. Why last 8/10 years? Because in the last 8/10 year we saw one of the biggest stock market collapse of all time (2008). They impact of the downturn was so huge that SENSEX plunged from 20,000 levels to 8,000 levels. The point is, if a period of 8/10 years can compensate a market collapse of this size, then minor short term volatility are meaningless. Such short term volatility deserved to be ignored and incoherent. Stock prices of even best of stocks halved during 2008 market crash. As on today, they are trading at nearly 3 times multiple. Today when SENSEX is at 26,000 levels, majority stocks are seeing their all time high levels. As a matter of fact, long term investing in shares can give average return of 12%. That this is a realistic return of a well diversified share portfolio.
Investing in Shares is safest through Mutual Funds
To reduce the risk of equity investment one can buy shares through mutual fund route. Equity linked mutual funds are perfect alternative for investing in shares for a beginner. Even those people who no nothing about equity can buy mutual funds.
Mutual funds are run by expert fund manager who know ins-and-outs of equity. They have been specially trained to invest in equity the right way. Mutual funds has one big advantage, their portfolio is very well diversified. There are different types of mutual funds available for investing. There are funds that mimic a particular index (eg Sensex). We call such funds as index funds. They are perfect for beginners. There are also fund that buy shares of a particular sector. Though these funds are high-risk funds, but it allows one to concentrate their holdings. A potential sector which is set to show growth in future can be targeted using such funds. But for sure, novice should stay away from them unless they have some insights. Systematic investment plans (SIP) in diversified equity funds are big Thumbs-Up for beginners.
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Disclaimer: All blog posts of getmoneyrich.com are for information only. No blog posts should be considered as an investment advice or as a recommendation. The user must self-analyze all securities before investing in one.