For a few, investing in a business or in the stock market comes with a calculated formula for success. They play with the numbers, weigh in the possibilities and then decide to take the plunge. For many others, it’s all about taking a wild guess and going for it.
Here are a few investing basics that might help you get in the right state of mind for successful investment.
What the cost of the business?
For any successful investor, this is the first question that pops into their heads whenever someone comes up with a pitch to them. Before everything else, you would want to know the net worth of the business. Do not just buy a stock because you like it. Trust the numbers before everything else. For simpler calculations, let’s say you’re investing in a $100,000 restaurant with an annual income of $10,000.
How much do I need to pay?
Here, you need to be aware of P to E or Price to Earnings ratio. If the difference between the amount of your investment and the return that you’re getting is less, then this investment has a lower and hence better P to E ratio because you’re getting more output out of lesser input.
You also want a higher percentage return on your investment. Let’s say you bought the aforementioned restaurant for $100,000 and earned $10,000 in the first year. The percentage return on this is 10%. Now, had you bought this same restaurant for $50,000 and yielded the same $10,000 income, the percentage return would have been 20%.
So, lower P to E ratio and higher percentage income is the way to go!
Owning one share is the same as owning the complete business:
This is very important to understand in order to comprehend how the stock market works, in general. If Windows has 2000,000 shares in the stock market and you bought only 1, the percentage income that you receive remains exactly the same as someone who would have bought each one of those 2000,000 shares!
Let’s say our $100,000 restaurant had 10,000 shares. Now each share would be sold in the stock market at $10 and the return on each share would be $1. The magnitude of the return has changed but the percentage yield is still 10%!
Understand that a share is a proportional ownership of the equity of the business that you’re investing in. This is just like eating pizza. Whether you have one slice of the pizza or all of it, the the energy you receive per bite does not change. This energy per bite is the percentage yield. What changes is the magnitude of how many bites of pizza you ate (i.e. the number of shares you bought) and the magnitude of how much energy you receive from all of those bites combined (i.e. the magnitude of return that you received.) The more you eat, the more energy you get!
Buying quality businesses:
What are quality businesses? Again, quality businesses aren’t the companies whose products you love or you think look pretty in the advertisements. A general assessment for quality companies is to see the number of competitors in the market and the amount of margin that they receive on their products.
You want to invest in a company which does not have an overcrowded market. You do not want to be one of the many people doing the same thing. Then again, you also do not want to be in a market where you are the lone producer of what you sell because more often than not, that’s just because there isn’t much demand for that product in the first place.
You need to find companies which have a balance between too little and too many competitors- a healthy number which gives everyone a fair share of the pie! Such companies tend to stick around longer which helps you get the return that you projected while investing in the first place.
You also want to invest in a company which has greater margins of income. If you look in the right place, you’ll find products with more than 200% return! For example, if a product costs $1 to the company and its retail price is $3, the $2 income is a 200% return on the product.
Look for “moats”:
To defend a castle, you need to build moats around it so that anyone who wishes to attack has to cross them first. In terms of businesses, a moat is the defense mechanism of a company that saves them from competitors. This might be a secret ingredient that makes their product better than others. It might be the unusually cheap prices of their products.
While investing in companies, look for moats that make them a better option for investment. The wider their moat is, the better to invest in them!