Learn how to invest

These last couple of years of financial crises has scared many people off from learning how to invest, and certainly from actually investing in the market. People are afraid that sustainable market gains are a thing of the past, and that nobody will ever make money in the market again. In this Learn new Skills article, called learn how to invest, we will look at some of the myths surrounding stock market investments, and also explain why it can be safe to invest in stocks if you invest for the long term.
 

How to invest in the stock market

Just to make this clear from the get go, Learn new Skills does not and will not recommend specific stocks to invest in or not to invest in. In other words, the “Learn how to invest” article series does not contain specific stock advice, only information about methodology and principles for your investing education only. What stocks you decide to place your own money in will be your own choice. None of the companies mentioned in this article series are in any way affiliated with this site or endorsed by this site.

Ah, great, now that we have got that out of the way, let’s look at the different methodologies investors commonly use when they invest in stock. As a side note, learning about investing is a lot about looking at what the time-proven investors have done, like Warren Buffett and Benjamin Graham. You will never find a detailed roadmap by studying them, but you will clearly see the framework they use to choose the stocks they invest in. Now, back to methodologies.
 

Value investment – Value investing – Long Term Buy and Hold (LTBH)

The investment style popularized by Warren Buffet and conceptualized by his mentor, Benjamin Graham, is in simple terms a method of buying companies with a long history of solid earnings, and with products that never go out of fashion (often because they have never been in fashion).

Value investors, or LTBH investors for short, often study the balance sheet in detail, and do Discounted Cash Flow analysis’s of the company’s cash flow to arrive at their estimate of value. This leads to one of the main tenants in LTBH, the specific notion of price vs. value.
 

Value vs. Price

Warren Buffett is famous for saying that price is what you pay for the stock, value is what you get. And these two are often completely out of synch. As an example, for much of decade of 2000, stock prices were far ahead of a stock’s, or underlying companies’, value.

A stock is simply a piece of paper (or electronic equivalent these days) that documents your ownership of a fraction of a company’s assets. This means that you actually own a part of the profit the company makes each year. You are in essence a company owner, on a small or large scale. This is very important to understand before you start to invest. Successful investing isn’t about lottery tickets, it’s about company ownership.
 

Learn how to invest = learn how to value a company

Since there is no way of concluding in a definite manner what a company is worth, the skills part comes to play in how good you are at estimating said companies worth. This is exactly where Warren Buffett excels. He is extremely good at valuing a companies assets and their long term earning power. He is also very attuned to recognizing management that can be trusted, and that has the talent to bring the company forward, even though he often says he wants to buy companies that could be run by monkeys (because their products are so good). Or perhaps that was Peter Lynch who said that, never mind.
 

Trustworthy management

This is another main principle in value investing, to find companies with management that can be trusted to do what’s best for the shareholders. With company scandals like Enron and Arthur Andersen starting to fade from memory, it is important to remind oneself that the people you are letting run your business are important. Investing in a company with bad management can literally be like throwing money out the window.

How do you spot good management from bad? Reading the annual reports from the company and noticing how the CEO communicates with the stockholders is one of the best ways to gauge the competency of the management. Also looking at the company’s track record for the last 5-10 years can give you clues. But ultimately you want to buy stock in a company where bad management really wouldn’t make that much difference. Yes, bad stewardship over years could dent the return on investment, but not bankrupt the company, as in the case of Enron and Andersen.

That’s about it for part 1 of the Learn new Skills article. Read more about investing in part 2 of Learn how to invest – coming soon