Retail investors often lose focus chasing price action instead of understanding businesses. As a retail investor who is looking to grow wealth through value investing in stocks for the long term, what are some useful tips to keep one grounded and focused, with a view to facilitating the achievement of one's investment objective over time? This question continues to recur over and over from our readers, and this article is an attempt to provide some guidance. We break down the mindset, company analysis steps, valuation basics, and discipline needed to succeed with value investing over the long term.
In a previous article we had outlined how to start investing in the stock market, with specific focus on the Nigerian Stock Exchange. If you are new to the Stock market, find the article here.
To attempt to answer the question, here are some tips to always keep in mind:
Stocks Are not just Ticker Symbols:
As an investor, one thing to always remember is that stocks or shares are not just ticker symbols- they are actual part or fractional ownership in companies, and in the long run it is the performance of such companies that determine the direction of their stocks/shares. As Warren Buffett would say, "in the short run the stock market is a voting machine, but in the long run it is a weighing machine". Which means that in the short run stock prices can go up and down depending on sentiments, but in the long run it is the actual company performance that determines the trajectory of its stock price. Always keep this in mind.
Company Performance:
If the above reminder is true, it therefore implies that we need to understand how a company is performing as a precursor to investing in its stock. A good understanding of a company of interest before investing in it would help an investor make informed decisions. Some questions that should come to mind include: what does the company do, which industry does it play in, is it profitable, how does it make profit, what are its growth prospects and what stage of growth is it in, who are the management team and how capable are they, are they people with a track record of integrity, who are its competitors, how is it fairing in relation to its competitors, is it gaining market share, does it have a moat or competitive advantage, is its profitability sustainable, is it innovative, etc. These questions and more will help you develop a convincing and compelling narrative or story behind your investment decision and keep you less distracted from the noise in the market, including share price movements.
Market Valuation above Stock Price:
As an investor you should think more in terms of the total market valuation of a company than just the stock or share price. A stock price can appear cheap relative to others, but the market valuation of the company might be expensive. This is what Buffett was referring to when he talked about buying stocks like groceries. It is by looking at the market valuation of a company that you can determine if it is cheap, expensive, or moderately priced, which would then guide your investment decision. It gives a wider view than the narrow share price view. To determine the market valuation of a company, simply multiply the share price by the total shares outstanding of the company. For example, we once thought a particular stock was expensive and stayed away from it for a long time until it occurred to us to check the market valuation. Then we realised that although the stock price looked high, the shares outstanding was small, leading to less valuation than its pairs in similar industry. It was then that we looked at other indices and finally jumped in.
Let's also use this avenue to segue into another dimension of this subject, which is the illusion that a lot of newbies in investing usually have, that because their cash outlay for investment is small and a stock price appears to be high they would not invest in it, as they would be getting few units for their money compared to investing in penny stocks which would deliver much more units for the same amount of money invested. Again if Market valuation is the focus one would easily see the flaw in this illusion. A highly priced stock might be cheaper in terms of market valuation than a low priced stock or even a penny stock.
Company Valuation:
When one has an idea of the market valuation of a company relative to its share price (essentially how much the market values the company at), one can then dive into valuation analysis of the company to determine if there is any significant disparity in both that one can take advantage of. Company or Business Valuation is simply determining what the company is worth. There are several methods to value a company or its stocks, which we will not delve into here. However some of them include Earnings multiples (price to earnings ratio), Revenue multiples (price to sales ratio), Discounted Cash Flow method, Book Value (Shareholders equity multiples; Price to book value ratio), etc. Once the company valuation is higher than the market valuation (or capitalization) of the company, then it could present an entry opportunity amidst other checks that an investor has to do.
There are several other tips that can be highlighted. However, in order not to make this article too long, we would stop here. As a long term investor understand that stocks/shares are part ownership in companies, try to understand the company you want to invest in, focus on market valuation and company valuation as against just share price, be sure to ignore market noise and short-term volatility, build an investment thesis and stick to it, and update your knowledge as companies evolve.
We hope that this would provide guidance especially to retail investors and would help you remain grounded and focused in the pursuit of your investment objectives.
Happy Investing! Feel free to share this article.
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