So you want to invest in the stock market, huh? Here's a quick video as a stock market primer. We'll dive deeper after the video.
The video is a little dated and certain aspects, like the ticker tape, are a little outdated. But these are the basics of how a stock is listed as well as traded on the stock exchange. It is an absolute classic and is probably the best and easiest way to explain and understand the stock market. Shall we continue?
First, before investing in any company, it's important to get the basic facts about the company. It's also important to understand that you aren't simply buying letters that flash on a screen, and their prices just go up and down. If you are going to invest in the stock market, understand that you are buying into real businesses that have real customers and that have real expenses to pay. If you buy a stock, you are a business owner, plain and simple. Would you invest in a business that loses money? Would you invest in a business that doesn't offer you a return on your investment in the form of dividends? Thinking like a business owner, and not simply looking at stocks as a get rich quick financial vehicle, is the best way to approach the stock market. I guess the stock market is really a business market so let's start looking at businesses.
There are so many investors, or should I say speculators, that treat the stock market as a gambling mechanism. They hear a new hot IPO, like Alibaba (BABA), and want to throw their money into it and hope for the best. Before we even begin to dream of the millions we could make in the markets, we need to know how the company even makes money. If you don't know how the company generates revenue, you have no business investing in the company, period. Just because you heard someone on TV or a friend of a friend who's investing in a certain company doesn't mean you should. Understand how the business works, how it generates revenue, and then let's start looking at how well they manage their expenses.
If you aren't interested in pouring through a company's financial statement, then your'e better off investing in an index fund or ETF that pays dividends. You can skip the next couple of paragraphs and just scroll down to the table with the market's return.
For those of you who want to do your own investing, you'll have to first do your homework. This includes going to the company's website and looking through the company's financial statements to see how well the company handles the cash they generate. Does the company have a lot of debt? Does it generate enough cash from its operations to pay all of its expenses and pay a dividend? We want to invest in companies that have solid financial statements and pay us a dividend that is sustainable.
Next, you'll have to consider the price of the company. Is it worth paying $40 for a stock with no dividend or $40 for a stock with a dividend? I'd take the dividend every time. You would also have to consider, once you decide on the businesses to buy, what would be a fair price for those businesses. Do you want to pay 20 times their cash flow generating ability? What about the intrinsic value, or book value, of the company? Would you want to pay more than 5 times a company's book value? It's important to have a plan when you're in the business of buying businesses. You wouldn't just give money to anyone who wants to start or grow a business, so why would you think this was ok when investing in the stock market?
This amazing table was built by Tristan Hume. With it you can track the returns of the S&P 500 with or without dividends, as well as the dividend yield of the S&P, over any time period you desire. This is a great tool, especially for those who like index funds, to see the returns of the market compared to other asset classes. Over the last 100 years, the S&P 500 with dividends has had an annual growth rate of 10%. If you're apprehensive about investing in individual businesses, an index fund could be your best friend. Right now, the S&P 500 is about 3.5% lower than its 52-week high. This doesn't mean stocks are fairly valued, but it does mean they've gotten a little cheaper. According to the Shiller P/E ratio, the S&P 500 is just under the same valuation it was in 2008.
Whatever your strategy is, it's important to remember that, when investing, it is a process that is going to take a while. It's also important to remember to invest money as often as you can. If you put $1,000 into the stock market and left it alone after one year and had a 10% return, you'd have $1,100. A 10% return is nothing to scoff at, but don't think all your dreams are going to come true if you aren't investing consistently for a long period of time. I understand that your initial investment can compound over the years, but the more you put into the market, the more compounding can work in your favor. The stock market isn't always going to have great returns, but if you have a plan and stick with it, you'll have a great portfolio of dividend paying businesses in no time.
