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Learning to invest in the stock market is different from say, learning maths. Whereas everyone eventually reaches the same solution in the latter, thereís no one right answer on how to invest well. Nonetheless, there are overriding similarities between learning the both, or any sorts of skills. The fastest way to learn a skill is to deconstruct it by breaking it into pieces, strip down to their essence, and examine the fundamentals.
Fundamentals provide a solid foundation, like a sturdy building holding up against shocks, so you wonít fall apart during a market panic. Investing is a slow learning process, same as everything you set out to do, like a car in first gear going uphill. And donít worry about missing out opportunities. If the boat is not in the right direction, it doesnít matter how fast it goes. Instead, aim for 1%, strive to improve yourself by 1% every day, it adds up over time. Build a long runway, and focus on what matters and ignore the trivial. When your knowledge compounds, your wealth follows.
In the stock market, every share you own is a slice of ownership in the business, essentially, you are the owner. You are entitled to vote, receive a dividend, if thereís one, and participate in the fortune of the business as a shareholder. You grow your wealth through the dividends received, and share price appreciation as the business makes more money.
Most investors watch their shares like a hawk, reasoned a drop in share price would impair investment capital. That is true if the shares are sold to realize the loss, but otherwise, flies in contrary to the mindset of an owner. If an asset can be acquired at a lower price, in this case, the whole business, isnít that a positive thing? As opposed to a falling share price, the risk of an investor comes from not knowing what he is doing. If one buys a property but never take the trouble to inspect, or walk around the neighborhood, is it a surprise if the house is in a poor condition sitting in an unsafe neighborhood?
Similar to doing research before getting a fridge, a car, or a house, a big part of investing lies in preparation, doing the work before buying, and spending the time to understand the business. These knowledge create a psychological edge, and the ability to think independently, a rare and valuable trait in investing during market panic. You can assess the situation with a calm head before making the right decision rather than rushing to the exit doors like everyone else.
Your profession or things that surround your daily life are good starting points to learn more about a business and industry. If you work in the I.T industry, chances are you will be familiar with some software providers; if you are a car enthusiast, which stores do you always visit and for what reasons? Even if youíre a stay at home mom, you might have developed a good understanding where to find quality ingredients. By observing things around you, you have a good judgment on whatís selling, and what doesnít. Look for the label, find out which company produce it and how well the business is doing.
Given the choice between a wonderful and an average business, youíll prefer to invest in the former. But how do you distinguish the former from the latter? Is there any characteristic that defines a company as wonderful?
If one of your friends comes to you with an idea of starting a business together, you will ask questions like:
1. What kind of business is it?
2. How much investment do I have to put into the business?
3. How much money can the business make every year and how fast?
The first question focuses on having a good grasp on what the business does. If your friend is going to start something that you canít get your head around, never ever get involved.
The subsequent two questions are the litmus test to see how attractive an investment can be, or how wonderful the business is. To start with something simple. If you decide to open a savings account, you would prefer a bank that offers a better rate, say 2% instead of 1%.
To express it in an equation:
The savings account earns you $2,000 / You have to put in $100,000 = You earn 2% return
or put it another way:
How much money can the business make / How much investment to put in = X% return
To simplify it:
Profit / Shareholders Equity = X% return (Return on equity)
Shareholders equity means the total amount of money that have been put into the business. Return on equity or ROE for short, expressed in percentage, measures how well the business is generating a return on its investment. In the savings account example, you get a 2 cents return for every dollar of investment or a ROE of 2%.
A business can report they made 1 million or 100 million in profit but that information has little value without knowing how much investment had been put in. The ROE decides how attractive a business is. In running analogy, a runnerís performance is determined by the time required to achieve an X amount of distance. In investing, it is the investment required to generate an X amount of profit that determines the share price & business performance.
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