Wednesday, August 17, 2022

A Primer on Stock Investing (Part 1)

The objective of this article is to summarize some key metrics of stock investments and valuation; and help investors make informed decisions using a relatively simple framework.

There has been a plethora of information on stock investing, regularly bombarded on investors by financial media. This flood of information is disseminated by multiple media channels. Some of these industry resources provide valuable information, yet these reports may not help in making informed decisions. Studies have shown that Value line, with its highly sophisticated analysis, can hardly compete with the Market index. Research has demonstrated that beating the Market index needs “superior” analysis and right timed execution. The term used for this unique skill is Alpha; and some examples of Alpha seeking Gurus are Warren Buffet, George Soros, Peter Lynch and others.

Before delving into a more pragmatic framework of stocks, it is important to define different categories of stock investing. Stocks are broadly categorized as either common stocks or preferred stocks. The key difference between the two is characterized by the following. First, preferred stocks are preferred, as the name implies, over common stocks in terms of claim by the shareholders in case of default by the company. Second, preferred stocks are purchased to get dividends (income) with less potential for appreciation; while common stocks may be used for both dividends as well as capital appreciation, with focus on the latter. Third, preferred stocks behave like bonds in some cases, as interest rates go up the price of preferred would typically go down. Interest rate variation has some degree of correlation with stock market as a whole because as interest rates go up the stock market gets hit. For individual common stocks, interest rate variation effects will depend on a number of factors, in particular the capital (or debt) structure of the firm.

Other categories of common stocks include: First blue chip stocks of well reputed Dow Jones companies with established history of dividends payments to investors. Second, value stocks are under-valued gems, likely to grow in the long run. Third, growth stocks as the name implies are growth oriented stocks which are priced higher because of their perception of appreciation in future. Fourth, cyclical stocks which are sensitive to swings in the business cycles. And fifth, stocks which stay calm during market swings such as Utilities.

The key metrics of stock investing are summarized below:

1-52 Weeks High-Low: Find out the price of the stocks prevailing in the stock market and compare the current price to past 52 weeks of high and low prices of the same stock. The idea is simple: stocks having lower price range in the rising markets have greater upward potential than stocks which have already reached high 52 比亞迪認沽證 week mark.

2-Market Capitalization: This metric reflects how big the company is. Market capitalization is obtained by multiplying the number of shares outstanding of the company by the prevailing market price. Typically stocks are classified as large cap, mid-cap and small cap stocks. Large cap stocks, like Exxon, generally do not have a great upward potential of price increase as compared to some gems in the category of mid-cap and small-cap stocks. The latter category of mid-cap and small-cap stocks has the highest probability of representing emerging star investments, which typically multiply and grow ten-fold in a certain time period.

3-Volume: This metric tells us how much dollars are being traded on a single day. Volume is computed by multiplying number of stocks in trading on a particular day by the average price. Blue chip stocks like Exxon, Microsoft and Apple have larger volume. In contrast, small and mid-cap stocks have smaller volume, thereby creating some liquidity risk.

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