No investment portfolio is complete without a significant proportion of stock market investments. The stock market is the market where shares of publicly traded companies are bought and sold. A publicly traded company like the name suggests is one whose ownership is open to all members of the public. This ownership is broken into stocks and owning a stock (share) in a company makes one a part owner. Stock prices are generally market driven. Stock ownership should be a part of one’s investment plan and the proportion of stocks should also be monitored and managed.
The best stock investor in the world, Warren Buffet advises that the best stock investment one can make is an investment in oneself. Learn about the stock market. Read the financial pages in the newspaper. Learn how to interpret financial reports. This will enable us to make better investment decisions and determine which stocks are worth our investments.
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Our main partner in the stock market is our stockbroker. We need to do a due diligence on our broker before committing to the relationship and do further evaluations periodically. The Securities and Exchange Commission (SEC) that supervises the activities of the stock market regularly issues new guidelines, we must be sure that our stockbrokers continue to be properly positioned. The fees of the stockbroker are also regulated by SEC, so ensure that your stockbroker charges you accordingly. Once we choose a stockbroker, we would open a CSCS (Central Securities Clearing System) Account with the Nigerian Stock Exchange through this Stockbroker. This account is where all the shares (securities) we own would be deposited because shares certificates are no longer in use. Our stockbroker should give us online access to this account, so we can monitor movements of stock in and out of our account and so monitor payments. For instance, SEC mandates that proceeds from the sale of shares should be credited to the seller’s bank account within T + 2 days; online access would enable us to ascertain when payment is due.
The four most basic considerations in choosing shares are investment objectives, risk appetite, investment tenure and ethical considerations. Investment objectives define what we want from the investment – cash payouts (via dividend), wealth growth (through increase in share price) or both. An older person may be more interested in cash payout whilst a younger person may want to concentrate on wealth building. Risk appetites define how well we can tolerate the fluctuations that accompany share prices. If we are very risk averse, it’s best to avoid the stock market all together and choose investments that assure us of principal and profit. Stock market investments can lead to loss of principal, but they are also a source of returns above 100%. If we have a low risk threshold, we can choose the stock with little price movements. Investment tenure defines how long the investment is for. Since share ownership is ownership in the issuing company, then the relationship should be medium to long term. Many people say, they came into the market and left after 4 weeks and made huge profits. But they don’t tell us the many times that strategy has failed – how many of them are on the Forbes Rich List? Buffet, the most successful and richest stock investor advises a medium to long term tenure for each investment. When looking at ethical considerations we look at the businesses of the companies we want to invest in. Some may choose not to invest in alcohol and tobacco manufacturers, others would not invest in companies that manufacture using child labor in developing countries.
When picking stocks, it’s best to pick companies one is familiar with their business e.g. household names. Companies with a wide customer base that can guarantee continuous flow of revenue to the company. But since the relationship is medium to long term, a company’s situation may change. So, follow your company in the news; read about their activities. Make financial projections from those developments. If for instance, one reads that CBN is repeatedly sanctioning a bank in which one has invested, we can safely conclude that the bank has management problems, which could ultimately lead to financial distress. It’s best to move one’s investment to a more professionally run bank. When bad news about a company emerges, its stock price is the first to suffer. Many shareholders just keep watching the stock price fall and hope for a reversal.
I advise that if the downward trend is caused by actual individual unfavorable conditions (and not general market conditions), it is best to cut one’s losses early, sell the stock and move on. Thousands of shareholders of the banks that failed to recapitalize in the 2005 Consolidation Exercise would now be wishing they had taken the step to sell instead of doing nothing.If in doubt about the significance of the news about a company on its share price, seek professional advice. Sometimes, it’s not just a company that has issues, it might be a whole industry – the same reactions should be applied to the stocks of all the companies in that sector.
In choosing stock, one must avoid the hype generated by the so called “hottest stocks”. Always do your due diligence and refuse to be coerced by your stockbroker who may have ulterior motives. It is not easy to coerce a person who has an investment plan to buy strange stocks. Your investment plan should indicate, the sectors of the stock market you want to invest in – at least 3 sectors, in order to diversify portfolio and spread your risks. Then within each sector, invest in at least 2 companies to broaden the diversification.
I always advise that we avoid borrowing (aka leverage) to buy stocks. When you borrow,interest rate is fixed, repayment date (for principal and interest) is fixed. How then can you borrow for an investment in which the principal invested can be eroded (reduce in value) and a positive return is not guaranteed? Even common sense dictates otherwise.
The market has cycles. We have all heard of “bull run” and “bear market”. The bull run is when the entire stock market and most of the stocks on it are increasing in price and value. The bear market is the opposite. Every bull run is followed by a bear market. It’s the length of each one that determines the overall performance of the stock market at the end of the year. We should always expect these cycles, they are the way in which the market corrects itself. Investment experts advise us to enter when the market is down and leave when the market is up. This is contrary to conventional wisdom, but it is very correct. When the market is down, share prices are generally low and many good stocks are underpriced. That is the time to buy, one would buy at a bargain. To leave when the market is up is to sell when stock prices are generally high. That way one would make a good return on the investment. In buying when prices are down, please note that there’s a big difference between damaged stocks and damaged companies. Damaged stocks are stocks that have low prices, but the underlying companies are doing very well. Damaged companies are stocks whose prices are low because the underlying companies are failing. In a bear market, buy damaged stocks and not damaged companies.
For the beginner, choosing stocks might seem daunting. The solution to that is to invest in Mutual Funds. A mutual fund is a pool of money collected from many investors for the purpose of investing. The fund can choose only a type of investment e.g. government bonds or company shares, or it can decide to invest in different or all types of investment vehicles. When one buys units of a mutual fund, the responsibility for picking the right shares is transferred to professionals who are have investment management training and are up-to-date with happenings in the market. They invest money from the fund in various company shares and pay a dividend annually or one can choose to reinvest the dividend in additional units of the fund. However, these fund managers take a fee for managing your investments, so the cost-benefit must be carefully weighed.
The stock market is a major vehicle for wealth creation and income generation for most investors. Many people have lost a fortune but many more have been enriched by it. As we have always counselled in this column, empower yourself with relevant information, work with the right partners and do your due diligence before, during and after you commit your finances to any investment vehicle. Happy investing.