Stocks are marketable securities that gives individuals, groups and firms part ownership of a company.
Stocks are commonly referred to us shares in the United Kingdom and are termed as stocks in the United States, hence the words stocks and shares are often used interchangeably to imply part ownership of a company.
A stock is the corporation of all the shares into which the ownership of a company is divided. A single share of the stocks of a company represents fractional ownership of the company in proportion to the total number of shares.
There are generally two kinds of returns that are generated by stocks, these are capital gains and dividends.
Capital gains from stock ownership represent the price appreciation of the stock from the time it is purchased. For example, consider a hypothetical company “A” with total outstanding number of shares at ten billion and the current price of a stock is trading at 0.50 pesewas on the exchange.
If you were to buy 100,000 shares of stocks of this company at 0.50p per share, your total equity in this company in monetary terms will be GHS 50,000. However, if the price of this company’s stock were to rise from 0.50p to 0.90p. It is a movement of 0.4 points.
This movement of 0.4 points represents a capital gain of GHS 40,000, thus 100,000*0.9p – 100,000*0.5p. Which will imply that your actual stack in this company is no longer GHS 50,000 but GHS 90,000.
Dividends on the other hand are interest payments received by shareholders of a corporation on annual basis. Dividends have no fixed value and are determined by the board of the company together with shareholders during Annual General Meetings. Usually, the amount of dividend to be paid rests on the performance of the company during the previous and the most recent financial year under review.
Stock investments are good because they promise continuous dividend income to the stockholder as long as the company remains in existence. Notwithstanding the benefits of stock investments, picking a good stock can seem like a puzzle when one is not equipped with the adequate investment education. There are several ways to choose stock investments and the approach may differ from person to person, but generally, all stock investors can be categorized into three major groups;
- The first group of stock investors are those who basically act on a whim, they neither plan nor do any in-depth analysis and calculations before making investment decisions.
- The second group are those who plan, analyse and calculate, but do so wrongly.
- And then lastly, we have those who plan, analyse and calculate their investment decisions and do so correctly. We want to focus on being among the third group of investors.
Again, there are also three broad approaches or ways to analyse stocks to make investment decisions;
- By using fundamental analysis. Which is done by looking at the annual report and financial statement of the company in question and studying them critically to make investment decisions. Typically this approach requires that a person is schooled enough in financial accounting and economics concepts and principles so as to be able to make sound meaning from the company’s annual report and financial statement.
- The next approach to buying stocks is using technical analysis – which is done by reading and studying chart patterns and using system technical indicators to spot entry and exit of positions. Technical analysis requires that there are online brokers to provide the platform for investors to trade stocks online.
- The third approach to trading stocks is mainly by intuition combined with simple fundamental analysis. Which is the approach I use and find more appropriate for beginning investors as well as those with little or no educational background in accounting and economic concepts and principles.
Also, I find this approach quite simple and less time demanding, as it can allow everyone enough room to make stock investment decisions with little or no education.
The intuitive approach to buying stocks is purely based on personal valuation of companies. To do this, the first caution to this approach is that, we do not start by looking at the price of the company in question. This is because, looking at the trading price and value of the company can influence an investor to make a bias and less thoughtful decision.
Therefore, we rather start by briefly looking at the annual report of the company so as to get a fair idea of what the company does, the company culture and module(s) of operation.
We then go ahead to ask how much this company will be trading and how much do we think it is worth. Essentially, we want to ask ourself how much we will be willing to pay for the entire business if we were to buy it.
We do all this without looking at the current gross value of the company on the stock exchange and then intuitively decide how much we will be willing to pay if we were to buy the entire business. Suppose we analyse company “XYZ” and intuitively settle on GHS20 million as the price we are willing to pay if we were to buy the whole business. This implies that we have valued the entire business, given all of its assets and liabilities at GHS20 million.
The next step is to write this figure down and then look at the current value of the company on the stock exchange and compare the two values. Suppose the current stock price of the company is trading at 0.4 pesewas and the company has 25 million number shares outstanding. This will imply that the current value of the company stands at GHS10 million (ie.25 million shares by 0.4p).
In this hypothetical example, it has appeared the value of the company falls short of our intuitively estimated value of GHS20 million. The interpretation is that, based on our analysis, company “XYZ” is undervalued and there is the tendency (a high probability) for its stock price to rise overtime. We then react by going in to take a long position on the stock of company “XYZ”.
On the other hand, if the actual value of the company were to exceed our intuitively estimated value of GHS20 million, the interpretation will be that company “XYZ” is overvalued based on our analysis and there is the tendency (a high probability) for its stock price to decline in the near future. In this case, we react by taking a short position on the stock of company “XYZ”.
This simple approach to choosing stocks has proved useful for several investing giants like Warren Buffet and George Soros. When Warren Buffet saw Petrochina it was valued at $35 billion but his valuation of Petrochina stood at over $100 billion, signaling to him that Petrochina was undervalued and that there was enough room for its stock price to rise. He bought into Petrochina and several years later its value rose to over $100 billion – it turned out Petrochina was a good investment for Warren Buffet.
In conclusion, one must understand that this approach to selecting stocks is not an exact science, and that things may not always turn out as one may plan. In investing, we do not judge the quality of a decision by its outcome, basically because by their nature, companies and markets are unpredictable.
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E.O. Essien is a Chartered Economist with accreditation from the Global Academy of Finance and Management (GAFM) and the Association of Certified Chartered Economist (ACCE). He is a professional currency speculator, economic columnist and Investment Analyst. You may reach him via email on elijahotoo.eo@gmail.com or on 0203656160, he will be glad to hear from you.
