Investing in stocks is HOT. Many new private investors have entered the market and everyone wants to be on this money-making train as well. At elfin, however, we believe that investing is stocks of individual companies can be risky, and that it is important to understand exactly what you are investing your money in. Hearing from your neighbor that Tesla made him a lot of money shouldn’t make you feel FOMO. In this article, we want to explain what’s involved if you want to invest in individual stocks. After all, how do you choose right stocks? What aspects should you consider and what is important to know? First learn, then invest!
Please note that we do not provide investment advice or stock tips. We just help you discover if investing in stocks could be for you. Investing involves risk and don’t invest with money you can’t afford to lose! Promise?
Purpose of investment
The goal of investing is to turn your money into more money. Grow your ability. To do this successfully year after year, it is important to observe a few rules, such as spreading your portfolio (not putting all your eggs in 1 basket), paying attention to costs and taking the long view.
In addition, a number of other aspects are important, such as keeping your emotions in check (not letting FOMO or fear drive you), always making sure you minimize your risk and, above all, not losing money. Everyone wishes they had bought Tesla shares or a few Bitcoins in March 2020, we can’t deny that (at the time of writing, both prices have gone through the roof), but getting in for fear of missing the boat is not always a good choice as far as we are concerned. The pain of losing money is greater than ‘if only I had…’.
Therefore, we believe that investing in stocks is riskier, and moreover, not a MUST. We’re fans of investing and have stocks in our portfolio, but if you’re uncomfortable with this, don’t want to do all the research or get restless: no problem. Investing in ETFs can then be a very good way for you to build wealth.
Read in this article what different types of stocks there are
Stock portfolio: How to choose right stocks?
Which stocks you should buy, we can’t tell you. We do not have a crystal ball and are not analysts who analyze stocks and markets on a daily basis. Never blindly take advice from people who aren’t either but want to tell you which stocks to buy.
Which stocks are a good investment is entirely personal. Moreover, you don’t have to invest in single stocks at all to successfully build long-term wealth. Would you still like to invest in stocks – which we understand, because it’s fun! – Then we recommend doing your own proper research. Think of investing in stocks as more risky.
Always remember that you want to minimize risk, and you do that by diversification. When you invest in an ETF, you automatically spread your money across many companies. With investing in individual stocks, you are betting on 1 horse. But if you want to invest in stocks, how do you choose right stocks?
Analyze
If you are going to invest in stocks, and you have a few companies in mind, it is wise to do an analysis to determine if this stock is buy-worthy. But beware! This is not a holy grail. An analysis may be correct, but not come true. There are always unexpected things happening in the world and in companies (think a pandemic, think an accounting scandal) which determines the price of a stock.
How to choose right stocks: 2 forms of analysis
To determine which stock is of interest to you, it is wise to do an analysis. You have 2 types of analysis. The best known are fundamental and technical analysis, often called FA and TA for short. These two currents are roughly opposed. Technical analysis is all about the question “When should I buy?” and is about timing. Fundamental analysis is the gathering of knowledge and understanding of industries and individual companies and answers the question “what should I buy?
Fundamental analysis
In fundamental analysis, you look particularly at the development of the company. What does the annual report look like, what is the profit trend, what are the competitors doing, what are the strategic plans and ambitions and what industry is the company in? Today, assessing the general economic situation and economic relations between countries is also part of fundamental analysis. Because what happens at the geo-political level matters to the economy.
Technical analysis
In technical analysis, you mainly look at the stock price and its movement. By looking at price charts or releasing calculations on historical prices, this analysis attempts to chart the likely course of prices. Looking at charts is called visual technical analysis (first current). Calculating with quotes is called statistical technical analysis (second stream). The first current is subjective, as it varies from investor to investor what he or she sees in a chart. The second is objective: any investor applying a statistical calculation will get the same result.
In addition to the premise that all information is contained in the price, technical analysis has two other basic principles. First: stock prices move in trends, and second: history repeats itself. Indeed, investors often tend to react the same way in similar situations. This is something you can capitalize on very well as an investor. Because if you recognize the trend before your fellow investor, you can make money.
Not easy
However, doing analyses is not easy and time-consuming. It requires knowledge and access to a lot of information. Banks have departments for this type of research, where professionals spend all day researching stocks and macroeconomic trends.
Another criticism is the rather high degree of subjectivity. It’s people work, doing fundamental analysis. Some consider revenue development important, others look more at how much profit is made, and others look much more at how the stock price compares to profits. People therefore say, “ten analysts, eleven opinions. So how to choose right stocks through analysis is and remains complicated.
The elaboration?
It is also difficult to estimate what effects fundamental developments will have on the stock price of a financial product, or when they will have an effect, and whether they will have an effect at all. Fundamental analysis assumes that the economy and financial markets act rationally.
However, much research has shown that this is definitely not the case. Therefore, an analysis can be correct but still not come true. In fact, reality can turn out very differently than the analysis predicted. As annoying as that is, the market is always right.
Factors to watch out for when investing in stocks
Just some inkers when it comes to long-term successful investing:
- Spread is key. ETFs, stocks, real estate, savings, paying off your own mortgage. Spread your money and investments.
- Time. Markets are irrational, especially in the short term. So: time is on your side! The longer you have time to invest, the better. Markets cannot be predicted, not by anyone, but over the past few decades they have shown an upward trend. History shows that despite falling and rising stock prices, including some violent moments of crisis, the economy recovers and shows growth. Then again, history does not necessarily tell us everything about the future.
- Make sure you have sufficient self-knowledge and have mapped out what your risk profile is (cq: what you sleep well with).
- Don’t invest with money you can’t afford to lose. Then put it in the savings account.
- Anyway, start with the basics first to get your finances in order.
- Before you start investing: teach yourself the basics so you know what you are doing with your money.
If you would like to invest in stocks, then there may be some factors worth investigating thoroughly. We list below some aspects you might study.
The Market
You first start looking at markets an sich. Preferably, you want to buy shares of companies in growing industries, where competition is low.
In addition, there are companies in the world that do well year after year simply because they are a good and healthy company, or/and because they operate in a market that is always in demand. Eating, drinking, mobility, health, personal care, etc. These companies can provide a little more stability, security and lower risk in your stock portfolio.
The Company
After studying the market, let’s look at the company itself. There are a few aspects (we’ll mention a few) that can help you determine whether you think the company is buy-worthy.
Pricing power
This trendy jargon means: can a company set its own price? And, if prices rise, can the company reduce volume losses at the same time? You see often commodity (energy, telecom) have a bit less pricing power , they cannot suddenly determine that their product will be 25% more expensive.
When we talk about pricing power, sometimes it is also interesting to look at companies that buy huge quantities so they can have super competitive prices. These companies can use this to create advantage and thus success.
Dominant position
In addition, you would prefer shares of companies that have a dominant position in their market. Case in point: the beer industry. There are 5 major companies that together account for 80% of the volume around the world. So these 5 companies are quite dominant.
Capital light models
Also look at the scalability of capital: if a company makes 1000 products in 1 factory, and they grow, and they suddenly have to open a2nd factory to do so, that requires a lot of capital, and so that can weigh on the operating profit.
Preferably, you want a company that can grow without having to invest too much in capital. This phenomenon is called Capital Light Models.
The balance
It is always important to see how the company you want to invest in is fundamentally sound.
It’s okay to take a gamble now and then, that’s what makes investing fun and exciting, but as we said, our goal with investing in above all long term making a positive return.
Anyway, after studying the market, for companies we have our eye on, we start looking at their balance sheets. A “good” company has no/little debt unless they have just made an acquisition. How much profit does the company make, how much debt do they have, do they have a lot of cash on hand?
Some companies have healthy balance sheets and realize incremental free cash flow. If this is the case, the company can do three things with this money:
- Paying dividends to shareholders
- Buying your own shares
- Reinvesting in the business
Why would a company buy its own shares? This can artificially influence the price of their shares.
Rating
Of course, you also want to look at whether the valuation, and thus the price per share, is realistic. A great way to see if the valuation is somewhat okay is to look at the price-earnings ratio, also called KW ratio. The pros say the wisdom is to buy shares of companies that have a price-earnings ratio of around 15. When it comes to KW ratio: the lower the better, because this means: how many times earnings is the share price
ESG policy
With a company, also check its ESG policy: environment, social, government. How does the company handle its responsibilities around reducing emissions? How does the company treat employees? Nowadays, SRI is increasing in popularity, and companies no longer get away with being scummy. In addition, government is important, and this says something about the integrity of the company and its management.
The strategy
Then you look at the company’s strategy and management. How does a company want to grow? Do they have a growth strategy by buying all kinds of other parties? Then that can weigh tremendously on the balance sheet. Preferably you have a company that also has an intrinsic growth strategy Will this company still be a winning and healthy company 10 years from now?
How many companies should you have in your stock portfolio?
Diversification is also very important if you are going to invest in individual stocks. We cannot repeat it often enough: first rule of investment is to not lose money. Second rule is to never forget #1. Putting all your available money to invest in stocks entirely into Apple – just to name one – is not a good spread.
But how to do it? And how many shares do you have to have before the spread is “good”? There is no one-size-fits-all answer to this, because again, it all depends on: your investment horizon, your risk appetite and your desired return.
Proposition rule of risk minimization
Because diversification is so important, having multiple types of stocks in your portfolio is important. With multiple stocks, you reduce risk. But this risk reduction does not continue indefinitely. When spreading over 8 stocks, you reduce the risk of an individual stock by 80%. At 16 stocks in your portfolio that drop in risk is 93%, Each stock you add after that lowers the risk only slightly. This is the
law of diminishing returns,
developed by Sam Hollander. If you have 500 stocks in your portfolio you reduce the risk of an individual stock by 99%.
Where do you invest in stocks?
You can invest in stocks at brokers that you would like to add to your portfolio. Consider DEGIRO or BUX Zero.
Conclusion: How to choose right stocks?
How to choose right stocks is a question that is not easy to answer. Nobody has a crystal ball, but a little common sense will get you a long way. If you check all these things, or better yet, keep your knowledge a little up to date, you can best decide for yourself which companies you think are worth investing in. Note: It has been proven that people who actively invest are far from always beating the market. Investing in a few strong ETFs can be just as profitable – or more profitable because you minimize risk more – than investing in individual stocks. Investing in stocks and doing good analysis beforehand takes a lot of time.
In short, and we can’t say it often enough: spread spread spread spread spread! But investing a lot of money in 1 company because you think this is going to be the next best thing , and then it turns out not to be, is a huge waste. Psychologically, it always hurts less to think about what money you could have possibly made than actually losing a lot of money.
