Investing in stocks is one of the best mechanisms to accumulate wealth. You can make a considerable amount of money with stock investing. You can also do it in a “passive” fashion. Meaning, once the stocks are purchased, they will literally make money while you sleep. This is a fact, not an opinion. Stocks alongside are Real Estate & Bonds have been used for centuries by millions of people to increase their net worth.
If you’re serious about making money and passive income you’re in the right place. Incorporating stocks in your portfolio of “money-making assets” can help you accomplish those goals.
Unfortunately, a lot of people miss out on the incredible benefits of stock investing. One of the main reasons people don’t take advantage of this money-making mechanism is confusion. They don’t know what stocks to buy, why, or when to sell. A lot of misinformation or “noise” revolves around stocks.
Some people “over complicate” stocks. But, as I will present to you in this article, stocks are incredibly simple. The first thing to set clear is the difference between investing in stocks and trading them. If people want reliable/healthy returns, I strongly believe they should invest, not trade. Now, let’s begin with some basic concepts.
Stock Investing Concepts – Lesson #1 – What exactly are stocks:
A stock is nothing more than a little piece of a company. This means that when somebody buys Apple stock, they are essentially gaining ownership of a tiny percentage of Apple. Because some companies are so big and valuable, small ownership could make you incredibly rich.
Market Cap is simply a fancy term that means “the total value” of the company. This value is calculated by multiplying the price of a stock by the total amount of stocks the company has emitted. The Market Cap of companies fluctuates because the stock price fluctuates.
Since a stock gives you “ownership” of the company, it is conceptually correct to think of purchasing stocks as purchasing assets.
You’re purchasing a fragment of a money-making company. Essentially, when somebody purchases stocks, they are becoming “micro-entrepreneurs”. If they purchased ALL the stocks a company has, then they will own the entire company! Just as some people own an entire coffee shop, hair salon, clothing store, or yoga studio.
Sometimes, large companies “buy out” smaller companies if they have adequate cash reserves. They do this when those smaller companies complement them, or need to neutralize their competition. For example, Facebook bought Instagram. A curious fact, Apple is currently sitting on so much cash, that it could buy all the shares of Netflix.
Generally, companies start as “private” and are solely owned by their founders. After they grow to a certain size, and they need more money to keep growing, they capitalize by making their stocks accessible to the “public” through an “IPO”. Initial Public Offering – the first day that the stocks start trading publicly on the market. Then the company becomes public, and anyone can own a portion of it.
Stock Investing Concepts – Lesson #2 – What exactly is the Stock market and why do stock prices change?
Well, it is simply a market place where stocks (shares of companies) are being bought and sold. There are several “market places” out there. For example, the New York Stock Exchange, or the Nasdaq (a market place that revolves around technology stocks). Stock prices change by simple supply and demand. When there are more buyers than sellers for a particular stock. The price of that stock increases. Conversely, when more people are selling a particular stock, than people buying it, the stock price starts to decrease.
Every day on Wall Street there is a “battle” going on between buyers and sellers. This battle causes the stock prices to increase or decrease depending on the number of shares sold or bought. Some trading sessions are very uneventful. Meaning there are no considerable fluctuations in the price. This occurs because there is a “stalemate” between the buyers and sellers that day.
Certain days are much more “volatile”. This means that there is a strong price fluctuation of the stock price in either direction. This fluctuation is created by a strong imbalance between sellers and buyers. A prime example of this is when catastrophic news started to circulate regarding the Coronavirus pandemic. Much more people were selling than buying, so the price dropped aggressively.
Stock prices also tend to increase or decrease significantly after a company reports its financial metrics. Every quarter companies share those metrics on the company’s quarterly “Earning Reports”. Think of this as a “scorecard” the company shows its investors which illustrates how good or bad they did the previous quarter.
This is very similar to a 4th grader showing their “report card” to the parents.
If the report card shows “great grades”, investors get excited about the news. Generally, investors are pleased with more earnings, more customers, lower costs, higher margins, or a new promising innovative product. If the news is good, investors typically flock in and buy the stock. This causes the price increases dramatically since nobody wants to sell due to the good news. The price will increase until buyers and sellers become “balanced”.
A very important point to discuss is that a lot of the increase or decrease in prices depends on “expectations”.
In certain occasions, what could be considered “bad news” actually causes the price to go up. This is because the news wasn’t “as bad” as originally expected. For example, let’s say parents think their kid is going to flunk out. Their expectation is their kid will have to repeat several courses. If the kid comes back with a “C” in all his classes (even though they are not As, or Bs) the parents will be pleasantly surprised. So, they could even “reward” their kid for that performance.
This tends to happen in the stock market A LOT! Sometimes the “report card” is not given by an individual company results, it is given by “the economy”. These types of reports focus “macro” factors such as unemployment, inflation, interest rates. For example, every Thursday, a “report card” is published which tabulates the number of new “jobless claims” that were filed the previous week.
Even though the Coronavirus generated tons of unemployment, the stock market rose! This was because even though a lot of jobs were lost, they were not as many unemployment filings as investors were originally estimating. This can be very counter-intuitive, how can stocks rise if there were 2 million jobs losses last week? Well, the market was expecting a number between 3 to 5 million, so 2 million is “positive” news.
Stock Investing Concepts – Lessons #3 – Now let’s focus on what Stock Investing & Stock trading consists of:
No matter what anyone tells you, there are only two things you can do in the stock market. You can either:
- You can invest in companies by buying and holding their stocks as “assets”.
- Or you can trade stocks which implies constantly buying and selling stocks. Essentially “flipping” stocks to other buyers.
According to various dictionaries, investing is defined as acquiring property or assets for securing long term capital gain. The keywords here is long term. Unfortunately, people tend to confuse “investing” with “gambling”, “speculating” or “trading”.
Thinking you’re investing when you’re trading happens more often than people would like to admit or even realize.
Gambling is defined as playing games of chance. Taking risky speculative action in the hope of a desired result. These “games” are usually short, like a ball jumping around a roulette in a casino for 15 seconds. Or someone buying a stock today and selling it tomorrow, otherwise known as “stock trading”.
What do stock investors do:
Investors approach buying stocks, very similarly to how entrepreneurs approach buying a small business or a franchise. Investors buy into a company that is solid financially, so they can consistently make money with that asset. They also want to hold their investment for a while to reap all the benefits from the ownership of the company.
No entrepreneur buys a great franchise today and sells it tomorrow. Very similarly, no Real Estate investor buys a solid property to sell it in a couple of months. (People that buy and sell frantically, are executing the Real Estate “flipping” or “wholesaling” business model. Not Real Estate “Investing”.)
There are a lot of parallels and similarities between Real Estate and Stocks. Real Estate investors want to buy a solid property, that will appreciate over the years. They also want to rent out to the property and collect rent. Stock investors also use a “buy and hold” strategy to gain both appreciations of the asset as well as “rent”.
In stocks, rent is called “dividend payments”. Solid companies tend to give out part of their earnings back to their stockholders through payments called dividends. Certain companies do this monthly, quarterly, or yearly.
What do they invest in?
Investors aim to partake in great companies. They want to own a little piece of a profitable company, not a crappy company that is losing money. So, they have a set of criteria to determine if the company is a worthy investment. Investors perform what is known as “fundamental analysis”, which is a fancy term for the study of the company’s financial metrics. The primary objective is to evaluate the “financial health” of the company.
Investors usually look at the company’s balance sheet to analyze the company’s assets and liabilities. They also look at the company’s income and cash flow statements. Their goal is to see the income the company generates, and the costs to generate such income. Investors like to see positive trends over the years. An example of a positive trend would be increasing their revenue (selling more products or services) year after year. Or their production and/or operating costs reducing year after year. Cost reductions would improve the bottom line (profitability).
Financially robust companies tend to appreciate in the future. Their stock price rises over the years. So once an investor determines the company is solid, they proceed to make a purchase.
How long do they hold their investments?
Investors are in it for the long run. Immediate price increases or decreases are irrelevant to them. If the price is down a week after they purchased the stock they don’t care. That is not when they are planning on selling! They are focused on what the company will be worth in 3, 5, or 10 years from when they purchased it.
Investors don’t care about losing small battles along the way, as long as they win the war. In a way, this is very similar to picking winning sports teams. Great sports teams might lose a couple of games every season. But they end up winning championships regardless of those “bad days”.
Predicting a long-term outcome is much easier than predicting a short-term outcome. What would you prefer betting all your money on:
- A great sports team will win their next game?
- A great sports team will win more games than they lose during the season?
Additionally, by staying in the market, you reap the benefits of all the good days. People that are buying and selling, are essentially trying to own a stock just the good days, and avoid the bad days. But they end up missing a bunch of great days because they had recently sold their positions. Sometimes they end up sitting on the sidelines during the best days and also miss out on dividend payments.
Look at any great company out there. For example, Apple, Google, Netflix, Microsoft. They all had their share of ups and downs through the years. But, in the long run, over a 5 or 10-year span their graph is ascending. Warren Buffett famously said: “our favorite holding period is forever”. If you want to know why, look at this:
What Stock Traders do:
Traders are speculators. Their game is not very different to betting a lot of money on a roulette or a blackjack table. They are gambling and not investing. They might win a couple of times and get that “instant gratification”. But, winning consistently is practically impossible because. Why? Because for the most part, traders are riding the emotional swings of the market. These short-term events are associated with a very high degree of uncertainty. Generally, trading is a “get rich quick scheme” based on speculative “games of chance”. Traders will win occasionally, but will also lose, it’s a matter of odds.
What traders buy and for how long?
Traders will purchase anything that they think will rise in value rapidly. These individuals will buy into anything today, that they believe they can quickly resell at a higher price. Sometimes they even go as far a purchasing Penny Stocks.
By definition, a penny stock is a junk stock emitted by a terrible company that nobody wants to purchase – that’s why it is cheap!
Remember in all aspects of life you get what you pay for, stocks are no different. But traders think they will be able to sell it for more money in a day or two, given a present trend. They usually sell those penny stocks to other traders, who think they can purchase it at that price and then resell it later higher to other traders. It is a speculation game that “feeds on itself”. This phenomenon is what generates bubbles!
A bubble is a situation where the price of something rises rapidly, most of the time without justification. The price will continue to rise until the bubble eventually pops.
The most graphic example of this was the “tulip mania bubble” that occurred from 1636 to 1637. In that madness, traders were purchasing and selling tulips to other traders at a higher price. They were able to do that because those other traders thought the prices were going to continue to rise. Tulip prices rose dramatically until the bubble burst – a tulip is a flower that dies in few days.
Investors don’t buy tulips, and they don’t buy penny stocks. Those are all short-sighted gambles based on “trendy shiny new objects”
Stock Investing Conclusion:
When approached correctly stock investing can be extremely profitable. You can enjoy very high ROI (Return on investment), just look at the cover of this article! Stock investing can and should be extremely passive. By passive I mean you don’t have to constantly manage your money, trade it, or move it around. You should simply put your money into good stocks, and let it sit there without manipulating it. Those good stocks should increase their value after a reasonable time-frame.
My ACTIONABLE Stock Investing Tips:
Now that you have gain more insight regarding stock investing, take action! Nobody ever became rich sitting on the sidelines. Open your personal brokerage account so you can begin investing. Start making money today! I suggest you take a look at my article on the best discount brokers to buy stocks! They offer some great perks like “commission-free” trades and free stocks when you sign up. Currently my favorite discount brokers are Webull and M1 Finance.
Additionally, investors should learn about diversification and spreading risk upon multiple great stocks, or perhaps hundreds. This concept is explained on my article about Index Fund Investing!