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What is a stock?
You know you should be putting your money to work by investing but you don’t have time to sift through all the information to learn about the stock market.
Everyday on CNBC stock tickers and prices fly across the screen and people talk about which went up and which went down.
Sometimes it seems like they’re going up and down with no reason.
If these professional analysts can’t figure it out how are you supposed to know what to invest in?
What if a stock goes to zero and you lose all your money?
Before we get into how to look at a stock price let’s first learn what a stock or share is.
When you buy a stock in a company you literally own a piece of that company.
If you bought all the shares of Amazon, then you’d be the sole owner of Amazon.
The reason you shouldn’t worry about stock prices dropping to zero for no reason is because they are pieces of businesses.
If the market dropped to zero, that would mean all the businesses in the USA were worthless and not making any money.
Let’s say you were looking at investing in Amazon but are worried that you could lose all your money if the investment goes to zero.
Realistically what are the chances that Amazon goes bankrupt and stops doing business?
Really, it’s gotta be close to zero.
And if you’re buying a piece of Amazon when you buy stocks you don’t have to worry all that much about your investment going to zero.
All intelligent investing is value investing – acquiring more than you are paying for. You must value the business in order to value the stock.
Charlie Munger
To accurately look at a stock price you should be looking at the company itself as part of your research.
Company Research
Now you know that when you buy a stock you are actually buying a piece of a business.
You’ll want to research both the qualitative and quantitative aspects of the company.
What are some things to consider?
- Sector
- Moat
- Management
- Company values
- Earnings
- Projected growth
- Debts
- Dividends
- Price
In this article we will go over the first half and focus on the qualitative parts of research into a business.
If you really hate numbers and you are in this for the long haul you could invest in companies based mostly on qualitative research.
Think of it this way- if a company is well managed, has a moat and well defined values and sticks to them you are investing in a good business.
If you find that company that will be around 50 years from now it won’t matter as much what the stock price today is. If the company is still going strong, there’s a good chance 50 years from now the price will be higher.
Sector
The sector of a company can tell you a lot about the business.
It can help you figure out if the business is cyclical. Or if the business is a necessity.
Is it a type of business that thrives when the economy is up or down?
Is the sector more defensive or more aggressive and growth based?
The 11 sectors that make up the market are:
- Energy
- Materials
- Industrials
- Consumer Discretionary
- Consumer Staples
- Health Care
- Financials
- Information Technology
- Telecommunication Services
- Utilities
- Real Estate
Energy
Companies you’ve heard of: Exxon Mobil & Chevron
These businesses are generally focused on gas, oil and renewable energy.They may not be sexy businesses but they are necessities in everyday life.
Some businesses might do better in summer when more people are driving, others better in winter when more people are using oil to hear their homes. Others still do well year round because they are in constant need.
Materials
Companies you’ve heard of:
These companies provide basic materials. Depending on what they make will determine if they are considered more cyclical.
For example construction materials companies will do well when the economy is trucking along and people are building. Once the economy slows down and people aren’t building as much they won’t need as many materials.
Industrials
Companies you’ve heard of: Honeywell, Lockheed Martin, 3M
These companies make products for businesses to purchase and either sell to and end user or alter for selling.
These products can be defensive and boring on one hand. Business will always need these products.
On the other hand they can definitely be cyclical and do much better when the economy is booming.
Companies are more likely to buy a John Deere tractor when they’re doing well.
Consumer Discretionary
Companies you’ve heard of: LuluLemon, Disney, Starbucks
These are companies that do really well when the economy is booming and tank when the economy dries up.
They provide things that people buy when they have a little extra cash.
Consumer Staples
Companies you’ve heard of: Procter & Gamble, Coca-Cola, Altria (makers of Marlboro)
These companies will do just fine during a recession because people will always need toiletries, cigarettes & beverages.
Health Care
Companies you’ve heard of: Johnson & Johnson, Pfizer
Drug manufacturers, health management companies and health care equipment companies all fall in this category. If it’s a drug manufacturing company you’re interested in, they might be very profitable while they hold a patent to a popular drug, like Viagra.
Financials
Companies you’ve heard of: Bank of America, Goldman Sachs, Allstate
These are companies that deal with all things money from banks to insurance to investing. In general these companies will do better when the economy is rolling.
Information Technology
Companies you’ve heard of: Google, Microsoft
Tech companies have lately been the darling of Wall Street because of their growth. They can provide massive profits when doing well and crater when the economy isn’t doing well.
Telecommunication Services
Companies you’ve heard of: AT&T, Verizon
These are not sexy companies. They provide services that everyone in today’s world uses- cell service and internet. They are essentially utilities. Not a ton of room for growth in those two areas but they aren’t going anywhere anytime soon.
Utilities
Companies you’ve heard of: Con-Edison, Duke Energy, American Water Works
These companies also aren’t sexy and aren’t going anywhere. Everyone needs the electricity, gas and water that these companies provide.
Real Estate
Companies you’ve heard of: Brookfield Property, Realty Income
These are companies that own the land that companies rent to do business or rent to tenants. Realty income for example rents space to FedEx, Seven-Eleven, Walgreens, etc. Brookfield rents office space, apartments, hotels, etc. Stocks within the Real Estate Sector are called REITs.
Moat
If it’s hard to compete against a company they have a good moat. Here’s a quote from Warren Buffet at the Berkshire annual meeting in 2000:
So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business. And we tell our managers we want the moat widened every year. That doesn’t necessarily mean the profit will be more this year than it was last year because it won’t be sometimes. However, if the moat is widened every year, the business will do very well. When we see a moat that’s tenuous in any way — it’s just too risky. We don’t know how to evaluate that. And, therefore, we leave it alone. We think that all of our businesses — or virtually all of our businesses — have pretty darned good moats.
Warren Buffett
There are a couple of major categories that consist of a moat or competitive advantage.
Economies of Scale
It would be extremely hard to compete with a company like Amazon or Walmart.
Why? Because they’re huge and offer cheap prices.
Walmart demands that a low price point be met from all their suppliers so they can give the lowest prices guaranteed in their stores.
Product differentiation
How is a company’s product different from their competition?
If you’re phone shopping are you going with Apple or Android?
What does a company offer that makes their product different than everyone else?
Android users like to say that they get the newest features.
Then Apple comes along and upgrades their phones to stay current but they offer a cleaner design and smoother user experience.
Capital Requirements
It would take a lot of resources to build an airplane.
That’s one advantage that Boeing has over any potential competition.
Even with all their recent problems the company will most likely stick around while people still travel by airplane.
Businesses that require a lot of capital to start will have less competition.
Less competition means more business for the companies already in that industry.
Government
Disney owns a lot of trademarks, drug companies have patents and tech companies have their own proprietary information that is protected by the government.
Don’t believe me? Go open a store and hang a giant golden M out front and call it McDougals and see what happens.
Why do you think all these companies and industries have lobbying firms?
So they can eliminate potential competition and guarantee their profits.
Cost Advantage
These are some of the moats that you should be looking for. The website futureblind.com has an interesting article diagramming a widening moat as a flywheel. Think of it almost like a self-fulfilling prophecy.
One example with Walmart in mind: Lower prices lead to more customers which leads to lower cost per item which leads back to lower prices.
The cycle continues.
And it gets harder and harder to compete against Wal-Mart.
Management
Do a little searching into the backgrounds of who is running the companies you’re looking to invest in.
If you were hiring someone to manage your shop you would research into their background and see what they’ve done in the past.
Well, you’re becoming a partial owner of a business so it’s a good idea to see who is running that business.
A lot of CEOs have track records and have led companies before, or are known for bringing in new ideas.
You can Google their names to find out what they’ve done in the past.
If you want to find out what current employees think of their CEO jump on Glassdoor.
They have a rating for each CEO, made from anonymous employee reviews.
Company Values
It’s not only important to know what a company does but also what it values.
What’s the first thing that pops into your head when you hear Chick-fil-A?
My pleasure.
They value great customer service and they make sure every part of their business provides that experience.
What’s the first thing that pops into your head when you think about Apple?
A top notch, stylish, high end and easy to use product.
Their stores, website, commercials all drive this point home.
It wasn’t long ago that Apple was associated with bad labor conditions in China. Similar stories have plagued Nike and Victoria’s secret in the past.
But these companies stuck to their values and pushed their message to overcome unwanted labels.
Now take a store like JCPenney.
What are their store and brand values?
Are they mostly cheaper clothing? Or brands? Are they trying to compete with stores like Macy’s, TJMax, H&M or Zara? All those companies are targeting different customers.
The store has gone through a lot of changes lately partially because they have an identity crisis.
The values that a company has should be easy enough for you to understand.
If you can’t understand the business and how they make money it’s probably not smart to buy into it.
Wrapping up
Before you get lost in all the numbers that have to do with a stock price take a breath.
Remember that when you’re buying shares in a company you are buying a small piece of that business.
Get to know the business first.
Look at the sector, any competitive advantages and barriers to entry, management and company values.
When you get to know your business it’s not so scary using your money to buy stock.