Investing in shares for beginners can be tricky…

What are the best shares to buy for beginners in India? Investing in shares for beginners can be tricky as they are not very conversant with stock investing.

While dealing with shares, beginners must realise that they are playing with fire. If beginners invest in stocks without sufficient know-how, it is like playing with fire.

Hence learning how to invest in shares is essential for beginners.

Shares are inherently risky form of investing money. The risk of loosing what is invested is very high.

We all want to earn high returns on our investments (ROI). But the probability of making big losses is also very high in shares.


If practiced with knowledge and care, share investing in India can give high returns, even to a beginner.

But before buying ones first shares, a beginner must FIRST know about the alternatives of shares. Why?

It is only logical to first compare and then arrive at a conclusion. Comparing alternative investment options will highlight pros and cons of shares to a beginner.

Alternatives available of shares are:

Mutual funds and exchange traded funds (ETF’s) can also be seen as an alternative of shares.

Investing in them is like indirect investing in shares.

Select the right investment alternative

Beginners must select the best alternative for themselves. And the best alternative will be the one that commensurates ones requirements.

But this is also true that requirement alone cannot drive the selection. There are other two important control points: (1) Available time horizon, and (2) Risk profile of investor.

It is essential for beginner to understand this concept clearly. Allow me to elaborate on this…

When I was learning to ride a motor bike in an early age, my objective was to learn and drive the bike like a racer.

But eventually I realised that with my skill-set, I cannot drive the motor bike beyond a certain speed. It is too risky.

Moreover, I also became aware that, the fastest my bike can run is at 120Km/hr. I do not have a bike like Valentino Rossi. 🙂

This kind of realization is essential for investors as well.

We all want to earn high returns. To earn high returns we must keep our investment locked for long period of time. Do we have that much time in hand?

To earn high returns we must invest in riskier alternatives (like shares). Do we have a personality that match the required risk profile?

A beginner can build ones risk profile. While starting, when knowledge about shares is zero, risk profile is very narrow. In this situation investing in shares will predominantly lead to losses.

But with knowledge gathering, risk profile becomes wider and wider. In such situation, investors are more likely to take calculated risks. Here the possibility to earn high returns is very probable.

So for a beginner, knowledge gathering about shares is key.

Why shares investing?

If requirement is to earn high returns, then the preferred alternative should be direct investing in shares.

There is no doubt that good shares can give higher returns.

It is essential to buy good shares and hold it for long term.

What it means by good shares? Shares of fundamentally strong companies, bought at a right price becomes good.

Does it means that buying stocks of companies like TCS, RIL, HUL etc at low P/E ratio is good enough?

No matter how big is the company, if it is not bought at right price, it is not good. Low P/E ratio tells very less about the price valuation of a stock. Hence use of other stock analysis methods is important.

So good stock bought at right price will do the work, right? No, it is also important to give it the time to grow. Otherwise 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. The longer is the holding period the better risk aversion is possible.

Risk aversion means, less probability to face losses.

Lets look at some risk aversion methods that a beginners can follow to earn high returns from shares….

#1. Invest for Long Term

 

Investing in shares calls for long term holding.

But what means by long term? Just saying that hold for 4-5 years is right?

Truly speaking, before one can quantify what is long term, it is important to attach a goal to shares purchase. Link a goal 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 the holding period is as long as 10 years, the returns starts becoming very predictable.

#1.1 Why long term holding

But why long term returns of shares are high & predictable?

Shares represents stake of shareholders in a company. Shareholders are like proportional owners of a company.

When more shares are purchased, the proportionate ownership of shareholder also increases. Company uses shareholders money (as shareholders capital) to operate business.

They also use this money to fund their expansion & modernization projects. Execution of these projects helps the company to increase its profitability, competitive edge, and the market share.

It takes time (minimum 3 years) for companies to execute these expansion and modernization projects. Till the projects are executed, their positive impact is not felt either on sales or profits.

This is one reason why, investors must buy shares and hold them for 3 years or more.

When profit of company increases, its stock metric EPS (earning per share) also increases. Any change in EPS directly effects market price of shares.

If company is able to increase its EPS at a faster rate, market price will respond accordingly. In fact in most cases, market price overreacts. This is the reason why we see some good stock trading at exorbitant P/E ratios.

Generally for a good company, EPS growth rate in long term horizon surpasses the rate of inflation.

Hence, long term holding of shares can give protection to investors against inflation.

….read more about best investments for long term.

#2. Invest for Dividends

 

Investing in shares is best when done for earning dividend income.

How?

Profits of company is distributed among shareholders in form of dividends. Distribution of dividends are generally done once per year.

Unlike capital appreciation, dividend payments are more predictable.

Companies which pay dividends are most loved by investors. Why? Because capital appreciation of a good company will eventually happen. If such companies also pay high dividends, they immediately becomes investors favourite.

Dividend is like additional income that yields along with the capital appreciation.

Shareholders can benefit from investing in shares in two ways, (a) by capital appreciation, and (b) by dividend income or both.

Dividend is a very good value indicator for investors. A company which has distributed dividends in past, and it continues to make profits, is most likely to pay dividend in future as well.

A loss making company cannot distribute dividends consistently.

So looking at dividend history before buying shares is a very good strategy.

A stock bought at $1.0 and sold at $1.2 means, the profit of $0.2 per share (20%). If this share also yielded a dividend of $0.1 per share, then net gain of the investor will be $0.3 ($1.2 – $1.0 + $0.1; 30%).

#3. Invest in Large Companies

Investing in shares can be best when done in large companies.

The larger is the company, the more predictable will be its earnings & share price growth.

Large companies have strong working management. Customer & shareholders benefit from the entrepreneurial value creation of large companies. Hence it is better for beginners to start investing in shares of such companies.

How to find the predictability of share price? Predictability of price can be checked by means of charts.

On the internet, price chart of shares are available. Using these charts, long term price trend of shares can be established.

Just for example, I have provided here a comparison between TCS & SENSEX in form of a chart.

The uptrend that TCS has shown compared to Sensex is phenomenal.

For a beginner it will be interesting to observe that, in last 5 years TCS stocks have appreciated by 115%, and Sensex by 80%. But the chart is more erratic for TCS and comparatively smoother for Sensex.

What does it signify?

In short term, individual stocks price fluctuates more compared to a basket of stock like Sensex. Hence for risk averse investors, investing in equity through products like ETF is a good idea.

TCS is our example of a ‘Large Company’. Though even such large companies also show volatility in short term, but over long term (like 5 years), growth trend is evident. Example: TCS growing by 115% in 5 years.

Investing in shares - TCS_Sensex

But beginners, do not take me wrong. I am not asking you to just look at price charts and buy stocks. It is equally important to see other financial metrics of companies (sales, profit, net worth, asset, cash flow etc) before taking a final call.

#3.1 Learn to do stock analysis

I will not say that this is an easy work, but it is essential in stock investing. To make the work easier, I have prepared a tool (excel worksheet) that can help beginners to learn the process of stock analysis. This worksheet is detailed and builds a reasonable base for prospective share investors. 

For investors it is essential to keep a watch on companies sales, profit, net worth, asset, cash flow etc.

A history of companies EPS & net worth 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 if the EPS is not growing at desired rate, investing in such shares is risky.

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 can only take lower risk in shares investing (like beginners).

#4. Ignore short term volatility

Beginners can invest in Shares but must ignore the short term volatility.

Despite our huge liking for shares, it cannot be ignored that in short term price of shares are very volatile. This is why most people stay away from share market.

But this is also true that over a period of 7-10 years, short term volatility gets compensated. How? Lets see…

We can understand this by looking at SENSEX’s movements of last 10 years. Why last 10 years?

Because in the last 10 year we saw one of the worlds biggest financial meltdown of all time (2008-09).

They impact of this meltdown was so huge that SENSEX plunged from 20,800 levels to 8,200 levels.

The point is, if a period of 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 can be deemed as incoherent.

Stock prices of even best of stocks halved during 2008-09 market crash. But today, the same stocks are trading at 3 times multiple.

Today in Nov’2017 when SENSEX is at 33,200 levels, majority stocks are seeing their all time high levels.

As a matter of fact, people who invested in Sensex in Oct’16 would have still been making a annualized ROI of 10.4% per annum (though they faced the 2008-09 financial meltdown).

If the same person invested some where in middle of year 2009, the annualized return would have been close to 18% per annum.

These (10.4% to 18% p.a.) are realistic returns of a well diversified share portfolio.

Investing in shares - Sensex

#5. Invest through mutual funds

Investing indirectly in shares through mutual funds is the safest and best route for the beginners.

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 know nothing about equity can buy mutual funds without much risk.

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 focus their holdings in their favourite sector.

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 about the sector.

Systematic investment plans (SIP) in diversified equity funds are big thumbs-up for beginners.

Final words about investing in shares for beginners…

As a beginner, investing in shares and expecting to make profits right away can be a daunting task.

But with only little efforts, profit making from shares investing can be realized.

One thing that can certainly help an investor to make money in share market is the knowledge of stock analysis.

If one does not have time to learn this new skill, one can invest indirectly in stocks through ETF and mutual funds.

But if one can already decided that they want to invest in shares, following rule of thumb can prove very helpful:

  1. Identify your financial goals. Attach a goal to every share purchase.
  2. Identify large companies that also pay dividends.
  3. Then do a detailed stock analysis of your identified stocks.
  4. Buy stock of your screened companies, and stay invested for long term.
  5. Do not bother about shorter term price fluctuations of your holding stocks. Just hold on to your stocks.

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-analyse all securities before investing in one.

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1 Comment on "Investing in shares for beginners can be tricky…"

  1. Most of the beginner start trading to make quick money from the stock market. They trade without any prior knowledge or experience.

    Trading without education is the most common reason why people loose money trading. We must learn fundamental or technical analysis and risk management and to control our emotions while trading.

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