Introduction
Ready to dive into the exciting world of stock market investing? Whether you're just starting out or looking to sharpen your skills, this comprehensive course will empower you to navigate the dynamic financial markets and build a successful investment strategy.
Investing in the stock market offers incredible wealth-building opportunities, but it also presents challenges. This course demystifies stock market investing, giving you a solid grasp of fundamental concepts, risk management, and proven strategies used by successful investors.
Our goal is to equip you to make informed decisions, navigate market fluctuations, and seize opportunities. Whether you're saving for retirement, education, or financial freedom, this course provides the tools and confidence to start your investment journey.
But what if you could skip the heavy lifting and have expert analysts do all this for you? That's where EquityScan comes in! We provide comprehensive stock analysis, personalized recommendations, and ongoing portfolio management to help you achieve your financial goals.
Get ready for an enriching learning experience that will boost your financial literacy and set you on the path to a rewarding financial future. Let's unlock your investment potential together!
What You'll Learn:
This course covers key topics through text and video resources, including:
"Traders" vs. "Investors" and Investor Profiling
Stock Market Basics
Key Drivers of Stock Prices
Essential Stock Market Metrics
Company Analysis (with access to free historical data)
Estimating Future Stock Value
Portfolio Construction and Risk Management
You'll explore different investment styles, learn to evaluate companies, and build a diversified portfolio aligned with your goals and risk tolerance. And you'll see how EquityScan can simplify this process and help you achieve your investment objectives.
Traders Vs Investors
Traders vs. Investors: Key Differences
This course focuses on investors, but traders can also benefit from understanding fundamental stock market drivers. Traders might consider indices, ETFs, currencies, futures, and options instead of individual stocks. (Our mentoring service provides daily market opportunities and insights!)
Here's a breakdown of the key differences:
Traders:
Time Horizon: Short-term (minutes to months) β±οΈ
Goal: Profit from volatility ππ
Frequency: Frequent transactions π
Risk Tolerance: High π
Analysis: Technical analysis (charts, indicators) π
Investors:
Time Horizon: Long-term (years to decades) ποΈ
Goal: Build wealth over time π°
Frequency: Fewer transactions π’
Risk Tolerance: Lower π‘οΈ
Analysis: Fundamental analysis (company financials) π
Investor Profiling
Know Yourself, Know Your Investments:
Before diving into the stock market, it's crucial to understand your risk tolerance. This means honestly assessing your comfort level with risk and reward, and aligning it with your investment goals and current financial situation.
Identifying your investor profile early on helps you focus on stocks that match your risk tolerance. This saves you time, effort, and money! There's no point in chasing high-risk growth stocks if you can't stomach the volatility. Similarly, if you're a risk-taker seeking the next Tesla or Amazon, investing in stable, dividend-paying companies won't satisfy your investment appetite.
Why Invest in the Stock Market?
Exceptional Returns: Historically, the stock market outperforms other asset classes. The S&P 500 has averaged 10.7% annual returns over the past century! π
Start Small: Unlike some investments, you don't need a fortune to begin. Start with as little as β¬10! π°
Affordable Access: Online brokers make investing easy and affordable, with low commissions and access from your computer or phone. π»π±
Quick Liquidity: Sell your stocks in seconds and convert them to cash whenever you need. πΈ
Simplicity: Stock market investing isn't rocket science. Follow a simple process to build a portfolio that's right for you. π
It's easier than you think to get started!
Who are the key players in the stock market?
The stock market is a complex and dynamic environment with numerous participants, but some key players and entities include:
Investors: These are individuals or institutions that buy and sell stocks in the market. They can range from small retail investors to large institutional investors like mutual funds, pension funds, and hedge funds.
Stock Exchanges: These are the platforms where stocks are bought and sold. In the United States, the major stock exchanges include the New York Stock Exchange (NYSE) and the Nasdaq Stock Market. Each country often has its own primary stock exchange.
Brokers: Brokerage firms act as intermediaries between investors and the stock exchanges. They execute trades on behalf of their clients and provide various services, such as research and investment advice.
Market Makers: Market makers are financial institutions or individuals that facilitate trading by providing liquidity. They do this by constantly quoting bid and ask prices for specific stocks, ensuring that there's always a market for them.
Regulators: Government agencies like the Securities and Exchange Commission (SEC) in the United States oversee and regulate the stock market to ensure fairness, transparency, and investor protection.
Listed Companies: These are businesses that have issued their stocks for public trading on stock exchanges. Shareholders in these companies include both institutional investors and individual investors.
Analysts: Financial analysts and research firms provide information and analysis on stocks and the overall market. Their reports and recommendations can influence investor decisions.
High-Frequency Traders (HFTs): HFTs are traders who use computer algorithms to execute large numbers of trades in milliseconds. They often profit from tiny price differences and provide liquidity to the market.
Central Banks: Central banks can influence the stock market indirectly through monetary policy decisions that affect interest rates and the overall economy.
Media: Financial news outlets and social media platforms play a significant role in disseminating information about the stock market. News and rumors can impact investor sentiment and stock prices.
Options and Futures Traders: These traders use derivative instruments like options and futures contracts to speculate or hedge their positions in the stock market.
Day Traders and Retail Investors: Individual investors who actively buy and sell stocks in the short term, often trying to profit from price fluctuations. The rise of online trading platforms has made it easier for retail investors to participate in the stock market.
It's important to note that the stock market is a complex ecosystem, and the influence and roles of these players can change over time. Additionally, global financial markets may have different participants and dynamics depending on the region and market structure.
How does a company get listed on a stock exchange?
Getting listed on a stock exchange is like a company taking a big step to become a part of the larger financial world. Let's break down the process in simple terms:
Company Readiness: A company needs to be in good financial shape and meet certain requirements to be considered for listing. These requirements often include having a solid financial track record, a minimum number of shareholders, and meeting specific accounting standards.
Choosing the Stock Exchange: The company decides which stock exchange it wants to be listed on. Different exchanges have different rules and regulations, and companies usually choose the one that aligns best with their goals and business model.
Hire Advisors: The company typically hires financial advisors, like investment banks or underwriters, to guide them through the listing process. These advisors help the company navigate the regulatory requirements and prepare for the listing.
Due Diligence: Before listing, the company undergoes a thorough examination called due diligence. This involves a detailed review of the company's financial health, operations, and management to ensure that all information presented to potential investors is accurate.
IPO (Initial Public Offering): The most common way for a company to get listed is through an Initial Public Offering (IPO). In an IPO, the company issues new shares of stock to the public for the first time. This is like a company's "debut" on the stock market.
SEC (or Relevant Regulatory Authority) Approval: In many countries, including the United States, the Securities and Exchange Commission (SEC) or a similar regulatory authority reviews the company's documents and financial information to ensure compliance with disclosure requirements. Once approved, the company can move forward with its IPO.
Setting the IPO Price: The company, with the help of its financial advisors, determines the initial price at which its shares will be offered to the public. This is often based on the company's valuation, financial performance, and market conditions.
Going Public: On the day of the IPO, the company's shares become available for purchase by the public on the chosen stock exchange. Investors can buy these shares through their brokerage accounts.
Post-Listing Requirements: After listing, the company must continue to meet the ongoing requirements of the stock exchange, including regular financial reporting and compliance with listing standards.
Getting listed on a stock exchange is a significant milestone for a company. It opens up new avenues for raising capital, enhances visibility, and allows the public to become shareholders in the company. While the process involves careful planning and adherence to regulations, it ultimately provides the company with opportunities for growth and expansion.
Test Your knowledge - Quiz 1
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Macro βHigh Levelβ Drivers of Stock Prices
Supply and Demand
It might sound very simplistic but it is true, the price of a stock boils down to the laws of supply and demand. Put simply, if the volume of buy orders (Demand) is greater than the volume of sell orders (Supply), share prices will rise. Conversely, if the volume of sell orders (Supply) is greater than the volume of buy orders (Demand), share prices will fall.
Supply and demand play a fundamental role in determining the prices of stocks in the stock market. The interaction of supply and demand for a particular stock or the overall market influences its price. Here's how it works:
Supply of Stocks: The supply of stocks represents the number of shares of a particular company's stock that are available for sale in the market. These shares come from various sources, including the company itself (through IPOs or additional stock issuances) and existing shareholders (such as insiders, institutional investors, and retail investors) who decide to sell their shares.
Demand for Stocks: The demand for stocks represents the interest and willingness of investors to buy shares of a particular company. Demand is influenced by factors such as investor sentiment, economic conditions, company performance, news, and market trends.
Price Determination: Stock prices are determined by the equilibrium between supply and demand. When demand exceeds supply (i.e., more people want to buy the stock than there are shares available for sale), the price tends to rise. Conversely, when supply exceeds demand (i.e., more people want to sell the stock than there are buyers), the price tends to fall.
Market Orders and Limit Orders: Investors place market orders or limit orders to buy or sell stocks. Market orders are executed at the current market price, while limit orders specify a specific price at which the investor is willing to buy or sell. These orders interact with the supply and demand dynamics to determine the actual transaction price.
Liquidity and Bid-Ask Spread: The spread between the highest price a buyer is willing to pay (the "bid" price) and the lowest price a seller is willing to accept (the "ask" price) reflects the current supply and demand for a stock. A narrow spread indicates high liquidity and a more efficient market, while a wide spread suggests lower liquidity and potentially less trading activity.
News and Events: External factors like corporate earnings reports, economic data releases, geopolitical events, and news related to a specific company can significantly influence supply and demand for a stock. Positive news may increase demand, while negative news may increase supply.
Market Sentiment: Investor sentiment, which is influenced by emotions, market psychology, and perceived risk, can impact demand for stocks. Bullish sentiment tends to drive prices up, while bearish sentiment can lead to selling pressure.
Institutional Influence: Institutional investors, such as mutual funds, hedge funds, and pension funds, often manage large portfolios. Their buying or selling decisions can have a significant impact on supply and demand for specific stocks.
In summary, the stock market is a marketplace where supply and demand interact to determine stock prices. Various factors, including economic conditions, company performance, investor sentiment, and external events, influence the balance between supply and demand, which in turn affects stock prices. Traders and investors analyze these dynamics to make informed decisions about buying and selling stocks.
Fund Managers and Share Prices
Who can buy and sell stocks in large volumes? Fund Managers! They control massive amounts of money. If they decide to start selling stocks en masse, share prices will fall. If they decide to start buying stocks in mass then share prices will rise.
Fund managers get paid to deliver returns to investors and they get paid pretty hefty bonuses to outperform the broader market index. Therefore, a fund manager will move their money around in order to maximize the potential of the fund.
The performance of other asset classes will be a determining factor in deciding where a fund manager invests. Put yourself in the shoes of a Fund Manager. Just ask yourself one simple question, where can I get a return on investment that satisfies my investment goals with the least risk?
Economics, Government Bonds and Interest Rates
A Government Bond is basically a loan that you give to the government. The Government takes your money and they use it to build roads, pay public sector salaries etcβ¦. In return you get an interest rate (also knows as the coupon) every year. Bonds can be offered over different time frames e.g. 3 year, 5 year, 10 year and 30 year. At the end of the agreed timeframe you get your initial loan amount back.
In established economies like the US and German economies, government bonds are considered 'Risk Free'. In other words, there is no chance that the government will default on paying you back.
A Government Bond is considered by many investors to be very attractive because of its zero risk profile (in the majority of cases).
What does this mean for stocks?
Government bonds and interest rates can have a significant impact on stock prices. The relationship between these factors is complex and can vary based on several factors, including the economic environment and investor sentiment. Here's how government bonds and interest rates can influence stock prices:
Interest Rates and Bond Yields: When central banks raise interest rates, it typically leads to an increase in yields on government bonds and other fixed-income securities. As bond yields rise, they become more attractive to investors seeking a safe and predictable income stream.
Alternative Investment Options:Investors often compare the potential returns from stocks to those from bonds and other fixed-income investments. When interest rates are low, as is often the case during periods of monetary easing, bonds may offer relatively lower yields. In such situations, stocks may become more attractive to investors seeking higher returns.
Discounted Cash Flow (DCF) Analysis: Stock prices are often determined by estimating the present value of future cash flows generated by the company. Higher interest rates can increase the discount rate used in DCF models, reducing the present value of those future cash flows. This can put downward pressure on stock prices.
Borrowing Costs for Companies: When interest rates rise, the cost of borrowing for companies may increase. Higher borrowing costs can reduce corporate profits, which can lead to lower stock prices if investors anticipate reduced earnings growth.
Consumer and Business Spending: Interest rates can influence consumer and business borrowing costs. When rates are low, consumers may be more inclined to borrow and spend, which can boost corporate earnings and support higher stock prices. Conversely, rising interest rates can discourage borrowing and spending.
Inflation Expectations: Rising interest rates can be a response to expectations of higher inflation. Investors may adjust their portfolios in response to inflation concerns. Stocks of companies with pricing power or those in sectors that can benefit from inflation, such as commodities, may see increased demand during inflationary periods.
Market Sentiment: Market sentiment and perception play a crucial role. Sometimes, investors interpret rate hikes as a sign of a strong economy, which can bolster confidence and lead to higher stock prices. In other cases, rate hikes may be seen as a response to inflationary pressures, causing concerns and stock market declines.
Duration Sensitivity: The sensitivity of different stocks to interest rate changes can vary based on factors like the company's debt level, growth prospects, and industry. Stocks with longer durations (higher sensitivity to interest rate changes) may see more significant price fluctuations when interest rates change.
It's essential to remember that the relationship between government bonds, interest rates, and stock prices is not always linear or predictable. It depends on a variety of factors and can vary over different economic and market cycles. Investors and analysts closely monitor interest rate trends and their potential impact on both bonds and stocks when making investment decisions. Additionally, market reactions to interest rate changes can vary, as they are influenced by investor sentiment and expectations.
Let's look at 3 scenarios as examples:
Scenario 1: 10 year US Bond is paying an annual interest rate of 2%. Would that be attractive enough? Given that we know that on average the stock market returns about 10% per annum and pays an annual dividend of 2%, I would say not. Investors will most likely choose stocks over the low interest Government bonds. Effect on stock prices of Low Interest Rates: Usually Higher Stock Prices
Scenario 2: 10 year US Bond is paying an annual interest rate of 5%. Would that make Government Bonds more attractive than stocks? Now there is a choice. In a nutshell yes, at the very least a Fund Manager would start rotating out of stocks into the safer government bond. Effect on stock prices: Falling stock prices.
Scenario 3: 10 year US Bond is paying an annual interest rate of 8%. Would that be attractive enough? Absolutely. Stocks would be sold heavily by the fund managers in order to purchase the attractive government bond. Effect on stock prices: Heavy falls
This is why you should keep an eye on US, German and UK Government Bonds. All yields are low now (2019) which is why stocks are at record highs. But keep an eye out when they start rising, whilst the economy will be doing well fund managers will start looking at rotating into safer assets like the government bonds.
This poses another question, what factors affect bond yields? Let's talk about the economic environment.
Macroeconomics, Interest Rates & Stock Prices
Economies often swing between booms and busts, and the stock market reacts in surprising ways. The best time to invest is often during the late stage of a recession. Here's why:
Forward-Looking: Investors focus on future growth, not current conditions. Stock prices often reflect economic expectations 6-9 months ahead, meaning the recession's impact is already priced in, creating value.
Supply & Demand Shift: Savvy investors start buying when prices are low, anticipating recovery. Higher dividend yields (due to lower stock prices) attract institutional investors, further boosting demand.
Interest Rate Impact: Falling interest rates (common in recessions) make bonds less attractive, pushing money into stocks.
A prime example is March 2009. The S&P 500 bottomed out, then surged 60% by October 2009, despite the ongoing recession.
Conversely, during peak economic recovery, the stock market can become less favorable:
Overvalued: Rapid price increases make finding undervalued stocks difficult. Demand peaks, but as investors anticipate an eventual downturn, demand weakens, and supply rises.
Lower Yields: Rising stock prices lead to lower dividend yields, making stocks less attractive to institutional investors, further reducing demand.
Rising Rates: Central banks often raise interest rates to combat inflation, making bonds more appealing and causing investors to shift money from stocks to safer government bonds.
This inverse relationship between bond yields and stock prices is clearly visible when comparing the returns of 10-year US government bonds and a stock market index.
Important Note: The Unusual Times of 2014-2021 (and Beyond)
It's important to remember the unique context of this course. From 2014-2021, central banks implemented unprecedented policies like near-zero interest rates and quantitative easing. This was a response to the 2008 financial crisis and the COVID-19 pandemic, aiming to prevent economic collapse. These extreme measures aren't the norm!
Update 2023: Starting in 2022, central banks began raising interest rates to combat inflation. This shift in monetary policy is likely to have a significant impact on the stock market, making it even more important to understand the relationship between interest rates, bond yields, and stock prices.
Economy & Stock Prices
Several economic data points and indicators can significantly impact stock prices because they provide insights into the overall health of the economy, corporate profitability, and market sentiment. Here are some key economic data releases that can influence stock prices:
Gross Domestic Product (GDP): GDP measures the total economic output of a country. A strong GDP growth rate can be seen as a positive sign for the economy and may boost investor confidence. Conversely, weak or negative GDP growth can lead to concerns about a recession.
Employment Reports: Employment data, including non-farm payroll numbers and the unemployment rate, provide insights into the labor market's health. Low unemployment and strong job creation can be bullish for stocks, as it indicates consumer spending power.
Inflation Reports: Measures of inflation, such as the Consumer Price Index (CPI) and the Producer Price Index (PPI), can influence stock prices. High inflation can erode purchasing power and lead to higher interest rates, which may negatively impact stocks.
Interest Rates: Decisions by central banks regarding interest rates, such as the Federal Reserve's Federal Funds Rate in the United States, can significantly affect stock prices. Lower interest rates can make equities more attractive than fixed-income investments, potentially boosting stock prices.
Corporate Earnings: Company earnings reports, including quarterly and annual financial statements, are fundamental to stock price movements. Positive earnings surprises often lead to stock price increases, while disappointing results can lead to declines.
Consumer Confidence: Consumer sentiment and confidence surveys provide insights into consumer spending patterns. High consumer confidence is generally positive for stocks, as it indicates a willingness to spend and invest.
Trade and Economic Policy: Announcements related to trade agreements, tariffs, and economic policy changes can have a direct impact on the stock prices of companies affected by these policies, especially in industries with high international exposure.
Retail Sales: Retail sales data indicate the strength of consumer spending, which is a crucial driver of economic growth. Strong retail sales figures can boost confidence in consumer-driven stocks.
Housing Market Data: Housing market indicators, such as housing starts and home sales, can provide insights into the health of the real estate market. A robust housing market can have positive spillover effects on related industries and stocks.
Business and Manufacturing Surveys: Surveys like the Institute for Supply Management's (ISM) Manufacturing and Non-Manufacturing Purchasing Managers' Index (PMI) provide insights into the health of the business and manufacturing sectors, which can impact stocks in those industries.
Government Policies and Fiscal Stimulus: Announcements of government stimulus packages, tax policy changes, and infrastructure spending plans can impact stock prices, particularly in sectors expected to benefit from such policies.
Commodity Prices: The prices of commodities like oil, gold, and metals can affect the profitability and stock prices of companies in the energy, mining, and manufacturing sectors.
It's important to note that the impact of economic data on stock prices can vary depending on the overall market conditions, investor sentiment, and the specific industry or sector in question. Traders and investors often analyze a combination of economic indicators, along with technical and fundamental analysis, to make informed decisions about buying or selling stocks.
Inflation Data Metrics
Inflation data metrics are statistical measures used to quantify and analyze inflation, which is the sustained increase in the general price level of goods and services over time. Inflation metrics provide insights into the rate of price changes in an economy, helping policymakers, businesses, and individuals make informed decisions. Here are some key inflation data metrics and explanations for each one:
Consumer Price Index (CPI):
Explanation: As mentioned earlier, the CPI measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. It reflects the cost of living for the typical consumer.
Use: CPI is widely used to track consumer inflation, adjust wages, pensions, and government benefits for inflation, and make policy decisions. It provides insights into changes in prices for various goods and services.
Producer Price Index (PPI):
Explanation: PPI measures the average change over time in the selling prices received by domestic producers for their goods and services. It reflects inflation from the producer's perspective, showing cost pressures faced by businesses.
Use: PPI helps businesses assess pricing strategies, production costs, and profitability. It can serve as an early warning of potential inflationary pressures in the economy.
Personal Consumption Expenditures Price Index (PCEPI):
Explanation: The PCEPI is an inflation measure similar to CPI but focuses on personal consumption expenditures, which include a broader range of goods and services than the CPI basket. It is often favored by policymakers.
Use: PCEPI is used by the U.S. Federal Reserve as its preferred inflation gauge and informs monetary policy decisions. It provides insights into inflation trends that may not be captured by the CPI.
Core Inflation:
Explanation: Core inflation is a measure that excludes volatile components of the CPI or other inflation indices, such as food and energy prices. It focuses on underlying price trends.
Use: Core inflation helps analysts and policymakers identify long-term inflation trends by removing short-term price fluctuations driven by factors like energy price spikes or seasonal food prices.
Inflation Rate:
Explanation: The inflation rate represents the percentage change in a chosen inflation metric (e.g., CPI, PCEPI) over a specific period (typically a month, quarter, or year).
Use: The inflation rate is the most straightforward way to assess the current rate of price increase in the economy. It informs individuals, businesses, and policymakers about the state of inflation.
Cyclical Vs Defensive Stocks
Riding the Economic Waves
When building your portfolio, it's important to understand how different stocks react to economic shifts. Cyclical and defensive stocks offer distinct characteristics that investors can use to balance risk and potential returns.
Cyclical Stocks:
These companies are closely tied to the economy's health, performing well during booms and struggling during downturns. Think of industries like manufacturing, construction, and consumer discretionary (cars, travel, entertainment).
Economic Sensitivity: Highly responsive to economic changes ππ
Higher Beta: More volatile, with larger price swings π’
Earnings Variability: Profits fluctuate significantly π
Dividend Policies: Inconsistent, may cut dividends during downturns βοΈ
Defensive Stocks:
These companies provide essential goods and services, making them more resilient during economic downturns. Think of sectors like utilities, healthcare, consumer staples (food, beverages), and telecommunications.
Stability: Reliable performance regardless of the economy π‘οΈ
Lower Beta: Less volatile, with smaller price swings μμν λ¬Όκ²°
Earnings Stability: Consistent and predictable profits π
Dividend Consistency: Tend to maintain or increase dividends π°
Investors often use a mix of cyclical and defensive stocks. During economic expansion, cyclical stocks offer growth potential. During contractions or uncertainty, defensive stocks provide stability and income.
Remember that some stocks blur the lines between these categories. Always research individual companies and consider your own goals and risk tolerance.
Understanding cyclical and defensive stocks helps you make informed decisions and manage risk. You can even rotate into safer defensive stocks when economic uncertainty looms.
Navigating the Economic Cycle: When to Buy, Hold, and Sell
Understanding the economic cycle is key to successful stock market investing. Here's a breakdown of each stage and how different industries perform:
1. Full Recession (Buy Stocks):
Economy: GDP falling, interest rates falling, low consumer confidence π
Best Industries: Cyclicals and Transport (near the end), Technology, Industrials (near the end) π‘
Why buy during a recession? Investors are forward-looking, pricing in future growth before it happens. This creates opportunities when prices are low.
2. Early Recovery (Buy Stocks):
Economy: Things improving, unemployment falling, rising consumer confidence π
Best Industries: Industrials (near the end), Basic Materials, Energy (near the end) π
Why buy? Economic growth is picking up, leading to increased profits for these industries.
3. Late Recovery (Hold/Sell or Become Defensive):
Economy: Peak consumer confidence (but starting to decline), rising interest rates, flat industrial production β°οΈ
Best Industries: Energy (near the beginning), Consumer Staples, Services (near the end) β½
Why hold/sell or become defensive? Economic growth is slowing, and risks are increasing. Defensive industries offer more stability.
4. Early Recession (Hold and Start Buying Towards the End):
Economy: Low consumer confidence, peak interest rates, flat or inverted yield curve β οΈ
Best Industries: Services (near the beginning), Utilities, Cyclicals and Transports (near the end) π‘
Why hold and start buying? The market anticipates the next recovery, creating opportunities towards the end of this phase.
Why Buy Cyclicals During a Recession?
It might seem counterintuitive, but investors price in future growth. For example, FedEx (transport) might ship less during a recession, but investors anticipate increased shipping during the recovery, driving the stock price up before the economy fully recovers.
Understanding the "big picture" of economic cycles is crucial.
Test your Knowledge - Quiz 2
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Understanding Stock Market Fundamentals
Market Capitalization ("Market Cap"):
Market cap is simply a company's stock price multiplied by its total outstanding shares. It tells you the company's size and relative importance in the market.
Think of it like this:
Micro-Cap: Tiny companies, like ants π (under $300 million)
Small-Cap: Small but growing, like mice π ($300 million - $2 billion)
Mid-Cap: Medium-sized, like dogs πΆ ($2 billion - $10 billion)
Large-Cap: Big and established, like lions π¦ (over $10 billion)
Mega-Cap: Giants, like elephants π (over $200 billion)
Investors use market cap for portfolio diversification, choosing investment styles, and assessing risk. Smaller companies are riskier but offer higher growth potential, while larger companies are generally more stable.
Dividends:
Dividends are a share of a company's profits paid out to shareholders, usually in cash. Think of it as a "thank you" gift from the company. π
Key Dividend Terms:
Dividend Yield: The annual dividend amount divided by the stock price (like an interest rate on your investment).
Ex-Dividend Date: The date you must own the stock before to receive the dividend.
Record Date: The date the company checks who owns shares to send dividends.
Payout Date: The date you actually get your dividend payment.
Dividend Payout Ratio:
This tells you what percentage of profits a company pays out as dividends. A low ratio means they reinvest more for growth, while a high ratio means they distribute more to shareholders.
Earnings Per Share (EPS):
EPS is a company's profit divided by its outstanding shares. It shows how much profit each share represents. Higher EPS generally means a more profitable company.
Price-to-Earnings Ratio (P/E):
The P/E ratio compares a company's stock price to its earnings per share. It shows how much investors are willing to pay for each dollar of earnings. High P/E can mean high growth expectations, while low P/E might suggest undervaluation.
Price-to-Sales Ratio (P/S):
The P/S ratio compares a company's stock price to its revenue per share. It's useful for valuing companies with negative or inconsistent earnings.
Long and Short:
Long: Buying a stock, hoping its price goes up. Bullish! π
Short: Selling a stock you don't own (borrowing it), hoping its price goes down. Bearish! π»
Understanding these concepts is crucial for analyzing and valuing stocks. Now you have the tools to start building your investment knowledge!
Stock Financial Analysis
Introduction
So far, we've looked at the broader market perspective. Now, we're shifting our focus to individual stocks and how to conduct basic financial analysis. Our case study is Alaska Airlines (ALK). Historical research involves examining a company's past performance. If a company has consistently delivered results in the past, it may provide confidence in its future performance. However, this doesn't guarantee future results, but it helps us rule out companies with no track record. The upcoming modules will include video presentations. So, if you need privacy, grab your headphones!
Finally, we have created a checklist for the research. If you would like a copy please email [email protected].
Historical Research
How to access company information for Free?
Sales Growth Analysis
The first step in your analysis is to identify whether or not the company has a track record of sales growth. The bottom line is that you want to see that there is demand for the products and services that the company offers. You want to see evidence of sales growth year on year for the most part in the last 5 years.
EPS & Net Profit Growth Alaska Airlines
We would also like to see a track record of profit growth over the past 5 years. EPS and Net Profit growth is important. But both are not the same. Net Income is the overall profit for the company. But EPS is the Net income attributable to each share on issue.
Sometimes a company can increase its EPS without increasing its Net Profit by repurchasing its own shares. Whilst this is a positive for investors, we want to make sure that financial engineering is not the only source of EPS growth.
Operating Margins Alaska Airlines
We want to see company operating margins stable. The operating margin is an important measure of a company's overall profitability from operations. It is the ratio of operating profits to revenues for a company or business segment.
Expressed as a percentage, the operating margin shows how much earnings from operations is generated from every $1 in sales after accounting for the direct costs involved in earning those revenues. Larger margins mean that more of every dollar in sales is kept as profit.
Dividend Analysis
Dividends may or may not be important to you as an investor. It will really depend on your investor profile. But it is still good to see if a company has a track record of paying out dividends and also raising its dividend year on year.
Debt and Debt to Equity
Finding the Debt Sweet Spot: A Balancing Act for Companies (and Investors)
Companies need to strike a balance with debtβnot too much, not too little. As an investor, you want companies to borrow strategically, using the capital to grow profits. Excessive debt can hinder profit growth due to rising interest payments.
We'll focus on two key debt ratios:
Total Debt: The overall debt burden of the company.
Debt-to-Equity Ratio: Shows how much a company relies on debt versus shareholder funds. A higher ratio means more debt.
Debt-to-Equity Formula:
While most financial websites calculate this for you, here's the formula:
Debt-to-Equity = Total Debt / Total Shareholder Equity
Industry Matters:
Higher debt generally means higher risk, but it's not that simple with stocks. The industry context is crucial. For example, car manufacturers require massive capital and naturally have higher debt-to-equity ratios than software companies.
Always compare "apples to apples" by analyzing debt-to-equity ratios within the same industry.
What is Shareholder Equity?
Shareholder equity is what's left for shareholders after all liabilities are paid off. Think of it as the company's net worth.
High vs. Low Debt-to-Equity:
While high debt-to-equity is generally riskier, it can be beneficial if the company efficiently generates cash flow from its borrowings.
Share Buyback Schemes with Alaska Airlines
Share buybacks happen when a company uses its own money to buy back its shares from the market. This reduces the number of shares available, which can have some interesting effects:
Boosts Earnings Per Share (EPS): With fewer shares, the company's profit is divided among fewer shares, making each share seem more profitable. π
Increases Return on Equity (ROE): Buybacks can make the company's equity look bigger, potentially improving ROE, a measure of how well the company uses shareholder money. π
Signals Confidence: When a company buys back shares, it can signal that they believe their stock is undervalued and the future looks bright. πͺ
Tax Advantages: Buybacks can be a more tax-efficient way to return value to shareholders than dividends. π°
Flexibility: Companies can buy back shares when they have extra cash or when they think the stock is a good deal. π§
But there are also some things to watch out for:
Debt Risk: If a company borrows money for buybacks and the stock price falls, they could end up with more debt and fewer assets. β οΈ
Not Always a Good Sign: Sometimes companies use buybacks to artificially inflate their stock price or to offset stock options given to executives. π€
Share buybacks can be a positive sign, but it's important to understand the company's reasons behind them before investing.
Newsflow and Understanding Historical Data.
Mastering Stock Valuation: 3 Simple methods with Alaska Airlines
Forget the Past, Focus on the Future: Predicting Stock Prices
The stock market is all about what's coming next, not what's already happened. Investors want companies with growing sales and profits. We'll show you how to identify future guidance and share price targets to find those promising companies.
While there are many complex formulas for valuing stocks, we'll focus on three simple but effective techniques:
Analyst Price Targets: Learn how to interpret what the experts predict.
Simple PE Valuation: Use a common and easy-to-understand valuation method.
Simple PS Valuation: Value companies even if they aren't profitable yet.
Target Share Price based on Analyst Estimates
Target Share Price based on Price to Earnings (PE)
Target Share Price based on Price to Sales (PS)
Average Estimates
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A word of Caution
These target prices are derived from estimates, which are subject to constant change. To validate these estimates, you must engage in qualitative research. This process involves evaluating the company's competitive landscape, legal challenges, competitive advantages, and more.
Portfolio Building
During this chapter we will take you through a process of building a portfolio of stocks that is right for you. We will discuss:
Risk and Risk Management using Beta
Strategy Allocation
Stock Allocation
Screening for Stocks
Completing the Portfolio
Finally, in our experience the best way to learn is 'to doβ. In the stock market you need to get 'real world experience' in order to learn. Access your personal simulated trading account.
We will give you a real time live simulated account which will allow you to get started immediately buying and selling shares. Contact us to get a username and password for your own personal simulated trading account. The process of buying and selling shares will help you to understand the stock market.
An Introduction to Risk
Building Your Dream Portfolio: A Step-by-Step Guide
This chapter guides you through creating a stock portfolio tailored to your needs. We'll cover:
Risk and Risk Management using Beta: Understand and manage your investment risk.
Strategy Allocation: Choose the right mix of investment strategies.
Stock Allocation: Select the best stocks for your portfolio.
Screening for Stocks: Find promising investment opportunities.
Completing the Portfolio: Put it all together and start investing.
Learning by Doing:
The best way to learn is by getting real-world experience. That's why we provide a live simulated trading account where you can buy and sell shares in real-time, risk-free! Contact us for your personal login details and start practicing today.
Diversification
Diversification: Don't Put All Your Eggs in One Basket!
The golden rule of investing? Diversification! It means spreading your investments across different assets to reduce risk. Think of it like this: if one basket of eggs falls, you don't lose everything.
Why Diversify?
Reduces Risk: If one investment does poorly, others can cushion the blow. π‘οΈ
Smoother Returns: A mix of assets can lead to more consistent returns over time. π
Protection: Diversification helps protect against risks tied to specific industries or companies.
Better Risk-Return Balance: You can achieve a good balance between risk and potential reward. βοΈ
Lower Correlation: Choosing assets that don't move in the same direction helps reduce volatility. ππ
Geographic Diversification: Investing in different countries or regions further reduces risk. π
The Volkswagen Example:
Imagine you had all your money in Volkswagen during the 2015 emissions scandal. The stock plummeted over 30% in days! π± But if Volkswagen was only 5% of your portfolio, the impact would be much smaller. This is the power of diversification.
Key Lesson:
Spread your investments! Don't concentrate too much in any single stock. The next lesson will give you guidelines on how to allocate your investments effectively.
Stock Allocation guidelines
Building Your Stock Portfolio: How Much is Too Much?
Stock allocation is all about building a portfolio that fits your investor profile. But even after you've figured out your risk tolerance, it's crucial to avoid over-concentrating in any single stock. Even Warren Buffett makes mistakes β he once said investing in Irish banks was one of his worst!
Here's a quick guide on how much to invest in any one stock:
Mega-Cap, High-Dividend Stocks: Max 5% per stock (think established giants) π³
Large-Cap Value Stocks: Max 5% per stock (solid, well-known companies) π’
Growth Stocks: Max 2.5% per stock (smaller, riskier companies with high growth potential) π
Remember, these are just guidelines. Your specific allocations will depend on your individual circumstances and risk tolerance.
Beta: Measuring Risk in Stocks
You already know to spread your investments across different stocks to reduce risk. Now, let's explore how to fine-tune your risk level even further using a metric called Beta.
Beta (Ξ²) measures how much a stock's price moves in relation to the overall market (usually the S&P 500). Think of it as a measure of a stock's "jumpiness."
Beta = 1: The stock moves in line with the market. πΆββοΈ
Beta > 1: The stock is more volatile than the market (bigger price swings). π’
Beta < 1: The stock is less volatile than the market (smoother ride). μμν λ¬Όκ²°
Using Beta to Manage Risk:
Diversification: Mix stocks with different betas to balance your portfolio's risk.
Risk Assessment: Understand the risk of each stock in your portfolio.
Hedging: Use low-beta or even negative-beta assets to offset potential losses in high-beta stocks.
Asset Allocation: Choose your mix of assets based on your risk tolerance.
Benchmarking: Compare your portfolio's performance to the market.
High Beta vs. Low Beta:
In general:
High Beta = Higher Risk, Higher Reward π
Low Beta = Lower Risk, Lower Reward π’
Now, let's see how you can use Beta to build lower-risk and higher-risk portfolios!
Investment Strategy Allocation
For the purposes of this course we are going to pretend we have a 'medium risk' profile as a result of our Investor Profiling. During this step we need to allocate the 'weightings' or 'allocations' for each type of investment strategy. Because we are 'medium risk' we decide to place the following allocation into each type of Investment Portfolio:
Now we need to decide on an allocation for each strategy.
Stock Allocation
Now that we know how we are going to split up our money in terms of investment strategies it's time to start considering how much we are going to invest in each stock. For this we are going to pretend we have β¬5,000 to invest. The investment breakdown might look something like this:
Remember we are basing this on an investment of β¬5,000 in the stock market. The amounts above will change if we have more or less to invest. Here is a step by step walkthrough of the chart above.
High Dividend Stocks:
We are only investing 40% into High Dividend Stocks
This equals a total investment of β¬2,000 (40% of β¬5,000)
We will only invest 5% of the Portfolio in any one High Dividend Yield stock
We will only invest β¬250 in a stock (5% of β¬5,000 = β¬250)
We will only invest in 8 High Dividend Stocks (β¬2,000/β¬250).
Large Cap Value Stocks:
We are only investing 30% into Large Cap Value Stocks
This equals a total investment of β¬1,500 (30% of β¬5,000)
We will only invest 5% of the Portfolio in any one Value Stock
We will only invest β¬250 in a stock (5% of β¬5,000 = β¬250)
We will only invest in 6 Value Stocks (β¬1,500/β¬250).
Growth Stocks:
We are only investing 15% into Growth Stocks
This equals a total investment of β¬750 (15% of β¬5,000)
We will only invest 2.5% of the Portfolio in any one Growth stock
We will only invest β¬125 in a stock (2.5% of β¬5,000 = β¬125)
We will only invest in 6 Growth Stocks (β¬750/β¬125).
Cash: We are going to leave β¬750 in cash for opportunities if they arise.
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Earnings Season
Earnings season is a period during which publicly traded companies release their quarterly financial reports to the public, typically on a set schedule following the end of each fiscal quarter. These reports include information about the company's financial performance, such as revenue, earnings, expenses, and other key metrics. Earnings season is a significant event for investors, analysts, and the financial markets as a whole. Here's an explanation of earnings season:
Timing of Earnings Season
Earnings season typically occurs four times a year, following the end of each fiscal quarter. The most common quarters for reporting are:
Q1 (First Quarter): January to March
Q2 (Second Quarter): April to June
Q3 (Third Quarter): July to September
Q4 (Fourth Quarter): October to December
Companies have specific deadlines for reporting their quarterly earnings, and these deadlines are regulated by financial authorities like the Securities and Exchange Commission (SEC) in the United States.
Contents of Earnings Reports
Earnings reports, often referred to as quarterly earnings releases or financial statements, provide a comprehensive overview of a company's financial health during the preceding quarter. Key components of these reports include:
Revenue: The total amount of money generated from the sale of goods or services.
Earnings per Share (EPS): The company's profit divided by the number of outstanding shares of common stock.
Net Income: The company's total profit after deducting expenses, taxes, and other costs.
Operating Income: Profit from the company's core operations, excluding non-operating items.
Expenses: Breakdown of operating costs, such as research and development, marketing, and administrative expenses.
Guidance: Forward-looking statements or forecasts provided by the company's management about future performance.
Balance Sheet: Information about the company's assets, liabilities, and shareholders' equity.
Cash Flow Statement: Details on the company's cash inflows and outflows.
Earnings Calls and Analysts' Estimates
In addition to publishing their financial reports, many companies hold earnings conference calls with analysts, investors, and the media to discuss the results, provide context, and answer questions.
Analysts often provide earnings estimates before the reports are released. These estimates serve as market expectations against which a company's actual results are compared. A significant deviation from these estimates can lead to stock price movements.
Impact on Stock Prices
Earnings season often leads to significant stock price movements. Positive earnings surprises (when a company's results exceed expectations) can drive stock prices higher, while negative surprises can result in declines.
Market reactions can vary widely, depending on the company's performance, guidance, and the broader economic and market conditions.
Importance for Investors
Earnings reports are crucial for investors as they provide insights into a company's financial health and future prospects. Investors use this information to make informed decisions about buying, holding, or selling stocks.
Earnings season can also influence market sentiment and overall market trends, impacting various asset classes.
Earnings season is a key event in the financial markets, as it provides investors with updated information about the performance and outlook of publicly traded companies. It plays a vital role in shaping investment decisions, portfolio management, and market dynamics.
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