A beginner’s guide to invest in the stock market
Investment tips that can help beginners to maximise their returns from investing in stocks
Investing in the stock market is an effective way to create wealth as well as a hedge against inflation. If done prudently, stock investments can give returns much higher than other forms of investments such as real estate and fixed incomes. However, the stock market is multifaceted, complex, and volatile. To make smart returns, one should know the pulse of the market, and understand how it functions.
There is no proven strategy to maximise returns from stock. However, there are a few ground rules, if followed, can be instrumental in reducing risk and earning better returns.
Mentioned below are some of the investment tips that can help beginners to maximise their returns from investing in stocks:
Have in-depth knowledge of the business: It is advisable to invest in businesses about which, one has thorough knowledge. Investing in stock with limited knowledge of the business model might be counterproductive.
Diversification: Investing in a diversified portfolio of stocks can help in mitigating risk and maximise returns. Rather than putting all the eggs in one basket, it is advisable to invest across companies and sectors. This minimises the chances of market-induced risks. Meanwhile, it is also essential to keep in mind that too much diversification should also be avoided as it makes the entire process cumbersome. In case the ticket size of investment is very small (Rs 1-3 lakh), one should invest in 3-4 stocks. In case it is small (around Rs 10 lakh), one can consider investing in around 5-7 stocks.
Size of company: For beginners, it is suggested to invest in large-sized companies as it limits the risk. The size of the company can be calculated with the help of market capitalisation (market capitalisation is the product of the total number of shares with the price of each share.)
Valuation: Pinning your stock market investment on valuation is a popular approach used by many investors. Valuation is generally calculated with the help of the P/E (price/earnings) ratio, which is the ratio of the price of the stock by earnings per share. A high P/E indicates an overvalued stock. It also shows that investors are willing to pay more than the earnings of the stock, as they expect higher growth in the future. A low P/E, on the other hand, shows an undervalued stock. For beginners, it is advised to invest in stocks with a P/E of 10-25.
Earnings growth: A cornerstone to a successful investment strategy is to put monies in companies that can give consistent earnings. Only such stocks are profitable and enable investors to increase their wealth over a period of time. There could be companies (generally) start-ups with huge market sizes yet they have negative profitability. Beginners should avoid investing in such stocks. As a practice, it is suggested to generally track the past 10 years’ record of an enterprise to evaluate the profitability. Companies that have given consistent results in the past can be credible options to bet on.
Dividend record: Scrutinising a company’s dividend track record can give some perspective into the financial health of the company. It reflects the availability of free cash reserves within the company and also, highlights the fact that the company takes care of its investors. Meanwhile, if a company is not paying timely dividends, then there might be some flaws in the company’s finances. (However, it should be kept in mind that a good dividend distribution track record can’t be the sole criterion for a company’s robust future. Sometimes, it might indicate that the business may not have any concrete growth plan and hence, distributes its profitability to the investors. Such stocks generally have poor chances to grow in the future).
Liabilities: It is advisable to invest in the stock of companies that has limited liability. It can be evaluated with the debt-to-equity ratio, which is a comparison of the total liability of a company by its shareholder’s equity. A higher debt-to-ratio connotes more leverage in a company and such stocks should generally be avoided.
Note: There are a lot of companies that provide detailed company financials without any cost, where you can see complete compiled data of several years and compare the company’s data with its peers.
Authored by Ravi Singhal, Vice Chairman, GCL Securities