How To Invest In Shares: Value Investing For Beginners
Investing in quality shares is a great way to build wealth for the future. The only problem is, at first glance they look incredibly confusing and a little scary! The truth is, you don’t need to be a wall street banker to invest in shares. In this guide I’ve broken it down into the core fundamentals that will give you a solid understanding of how to invest. It’s very detailed, but I did my best to cut out all the fluff so it’s as concise as possible.
I actually wrote this blog for myself — I personally have never been great at math and I didn’t want to publish this until it made total sense to me. Hopefully, the result is a very easy to understand guide about share investing in plain English, not wall street jargon. If I can get it, then anyone can!
The opinions expressed in the this are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product. It is only intended to provide education about the financial industry.
When To Invest
Getting started in shares is easy — but you shouldn’t invest until you have checked off the items below. If you haven’t already read my blog Money Tips For Millennials (That They Don’t Teach You In School) that’s a good place to start to get your personal finances in order before you invest.
You’ve Paid Off All Your Debts
Pay off your debt (personal credit cards and loans) before you invest anything, because the interest on the debt will eat up any returns you make. If you make an 8% return but your credit card interest is 10%, you’re still losing money. You’re also at a greater risk because you may be forced to sell shares when you don’t want to, just to repay your debt.
You Have An Emergency Fund
Before you invest, you need an emergency fund with 6 months of living expenses in savings, so if you lose your income you aren’t screwed. E.g if your basic living costs are $2000/m, you need $12,000. This will give you peace of mind, and will help you keep a cool head when things get volatile.
You Have Money You Don’t Need For 5+ Years
Don’t invest money you will need soon. Value investing is about investing in great companies for the long-term and leveraging compound interest (more on this soon). Even though it’s easy to get in and out of shares quickly (compared to real estate), you want to do it because it’s the right time, not because you need money fast and are forced to sell. So if you need that money soon, best not to invest it.
If You Aren’t Ready, Learn Anyway
If you still have personal debt and don’t have an emergency fund — keep learning anyway. Stay educated and create an investment strategy so when you are ready you can jump right in.
Investing Mindset
Before we look at how to invest, it’s critically important to get your mindset in check. It sounds cliche but it’s honestly the most important thing and I see so may people get this wrong, then they lose money. Warren Buffet (the world’s greatest investor) says you don’t need a high IQ to invest in shares, you need emotional stability so you don’t make rash decisions.
Never Trust Mr. Market
Mr. Market is a hypothetical investor created by Benjamin Graham who is driven by panic and euphoria, and invests based on his mood, not fundamental analysis. He’s not very clever, totally unpredictable and has hardcore mood swings from optimism to pessimism. If he showed up at your house every day quoting prices for various shares, you’d be better off just ignoring him altogether. Sometimes his prices are suspiciously cheap, sometimes unrealistically high. The intelligent investor never sells a company just because its share price falls. The intelligent investor will always ask first whether the value of the company's underlying businesses has changed.
Control Your Emotions
As we know from Mr. Market… don’t give in to the hype! When things are going well, don’t just invest because you have FOMO, and don’t get greedy thinking ‘maybe it could go even higher!’. Likewise, when things are bad, don’t panic. Whether your portfolio is green or red, and whether the media is losing their minds about a bull market, or making you freak out about a crash, make sure you keep a level head.
Don’t Try To Time The Market
It is physically impossible to time the market, and if you try, you will go broke. You might time it well once or twice, but you can’t do it sustainably. So often I hear people say ‘how low do you reckon it will go?’ or ‘I’ll buy when it hits the very bottom’ or ‘I’m just waiting for the peak to sell’. You don’t get some alert when it’s at the very bottom, then another alert when it’s at the absolute peak. If it were that easy, we’d all be billionaires. If the top investors in the world can’t do it, neither can we!
People Are Irrational
Price swings often happen because people are irrational, not because the companies are failing. When the market soars, people buy because they ‘can’t lose’. When it tanks, they sell because ‘the world is ending’. This is the opposite of what you want to do! You want to buy great companies at great prices, and only sell if prices are unjustifiably high. As Buffet says: “Be fearful when others are greedy. Be greedy when others are fearful.”
Note: If you’re investing in a company for the long-term, a good strategy can be to buy a company you already own and understand whenever it goes down. This way if it goes up thats great, and if it goes down you have a buying opportunity.
Price Doesn’t Equal Value
Price is what you pay, value is what you get. Don’t buy shares just because it’s low or high. Buy it because it’s a good company with sound fundamentals and long-term growth prospects. The top investors say you should buy companies that you are happy to own, regardless of what the market is saying. Also, don’t buy a share because the individual share price is low (e.g articles that say ‘5 shares under $10). It’s completely redundant and makes no sense.
Make Your Own Decisions
Don’t invest in companies because your friend, the Uber driver or someone on YouTube said you should. If something they say interests you then you can look further into it, but you MUST do your own research and make sure you understand it. I’ve only ever bought 2 companies that other people told me to, one lost 99% of its value and the other lost 83%! A $7000 lesson about ignorance!
How To Withstand Volatility
Over your investing career you will experience crashes and corrections (when the market suddenly tanks out of nowhere). This is normal and inevitable, and they are actually the best time to invest because everything is on sale (if you don’t lose your cool). Some tips from William Ackerman:
Don’t panic sell!
Don’t follow the herd or give in to hype just because everyone else is.
Be financially secure. Feel comfortable you don’t need that money for years.
Don’t get spooked by short term fluctuations that are caused by world events that have nothing to do with the company.
Investing Basics
In this section, we’re going to look at the investing basics. By the way, in Australia they are referred to as shares, in America they say stocks. It’s the same thing.
What Is A Share?
When you buy a share (aka stock), you’re actually buying a small piece of the company. Because you own a piece of the company, as a shareholder you receive some of the profits which are paid through dividends. Most companies pay dividends twice a year, but not all of them. A company may not pay a dividend at all if they have failed to make a profit or they have chosen to reinvest profits back into the business.
Note — You may hear the term ‘income investing’ vs ‘growth investing’. Income investing is when you buy shares for the dividend income (e.g ANZ Bank), and growth investing is where you buy a share hoping that its value will go up significantly in the future (e.g Tesla).
How Do You Buy Shares?
Shares are bought and sold on a sharemarket (in Australia this is called the ASX). As an investor, you physically buy and sell shares through a trading platform like Commsec. Physically buying and selling shares is very easy, knowing which shares to buy is the real challenge. (For buying individual US stocks, you might like to check out Stake).
The Intelligent Investor
Warren Buffet claims this as ‘the best book on investing ever written’ by Benjamin Graham. If you want more detail check it out, but here is the core message of the book. An intelligent investor:
Always analyses the long-term evolution and management principles of a company before investing;
Always protects themselves from losses by diversifying investments.
Never looks for crazy profits, but focuses on safe and steady returns.
Compound interest
This is when you get interest on your interest, and if you’re young, this is your golden ticket to long term wealth. The sooner you invest, the more you'll earn with compounding. For example, you invest $100 and get a 10% return. Now you have $110 which gets 10% interest. Now you have $121 which gets 10% interest and so on. If you’re 25, start with $5000 and invest $500 a month, by the time you’re 55 this is $730,013! Check out this calculator and pop in your own numbers to see the power of compounding.
Note: This is assuming you leave your money IN shares and don’t take it out. Also, you only actually receive money when you sell, or receive a dividend. To make the most of compounding you want to use a dividend re-investment plan where instead of receiving cash, you get more shares.
Invest For The Long Term
When you invest for the long term you aren’t affected by short-term volatility. It doesn’t matter if it goes up or down 10% in a month when you plan on owning it for 20+ years. This also allows you to leverage compound interest, as long as you don’t invest money you need anytime soon. Remember — invest money you don’t need right now. If you can’t afford to lose the money or need it soon, you risk being forced to sell at a loss when you need the cash.
Diversifying
Diversifying is about earning the highest return for the least risk. If you have all of your eggs in one basket and that basket falls over, your portfolio gets hammered! Ideally, you want to invest in different industries, markets and countries. The easiest, simplest and most studied way to diversify is with ETFs and index funds (coming up in a moment).
Dollar-Cost Averaging
You don’t have to do this, but it’s a popular strategy. This is when you invest the same amount of money regularly, regardless of what’s happening in the market. E.g you invest $2000 every 3 months in your chosen shares or ETFs. If the market price goes up you’ll buy fewer shares, and if it goes down you’re able to buy more shares. (Note — you have to pay a brokerage fee of around $20 to make a trade. To avoid paying lots of fees, invest in chunks of at least $2000 at a time).
You Only Realise Gains Or Losses When You Sell
It’s important to note — share prices on a screen are all theoretical. You don’t realise’ a loss or gain until you sell. For example, if a share ‘drops’ 10%, you haven’t actually lost 10% of your money unless you sell it. Likewise, if it goes up 10%, you haven’t actually made any real money unless you sell it. So don’t panic when it goes down, and don’t get greedy when it goes up. It’s all on paper!
Exchange-Traded Funds (ETFs)
If you’re genuinely interested in analysing companies, that’s great! But if you just want to put your money somewhere smart and aren’t all that interested in understanding shares, reading the news and dissecting financial statements, ETFs (aka index funds) may be for you.
If you are only getting started in shares for the first time, this is the best section for you. I actually think 80% of the people reading this should just buy ETFs.
What Are ETFs?
The simplest, easiest, lowest maintenance way to invest in shares. This is when you buy a ‘piece’ of a large pool of companies, instead of buying one company. For example, if you buy one share of the Vanguard Australian Shares Index ETF, you’re buying a piece of the top 300 companies in Australia combined. This means you are instantly diversified, you pay extremely low fees and you reduce your risk.
85% of fund managers (with high fees) fail to consistenly beat the index over time. You can beat 85% of ‘experts’ by doing almost nothing!
Who Should Invest In ETFs?
ETFs are great for people who want a low-maintenance investment, don’t want to spend a lot of time reading charts, and are comfortable with a relatively boring strategy. Like I said, if you find shares confusing and have no interest in learning the specific, these are perfect for you. Full disclosure — 75% of my portfolio are in ETFs.
ETFs To Get You Started
ETFs by definition are already diversified, but you can diversify even more by investing in different countries and sectors. If you were to invest only in ETFs (which is a perfectly fine strategy) here are some percentages to help you build your simple portfolio.
VAS — The top 300 companies in Australia (50%)
VTS — The top companies in the US market. (20%)
VEU — The top global companies excluding the US market. (15%)
VAP — The top 300 real estate investment trusts in Australia. (15%)
How to Buy ETFs
You can buy ETFs the same way you buy a regular share, through a trading platform like Commsec. Simply search the symbol (e.g VAS) and buy as much as you would like.
Important Financial Terms
If you’d like to learn more about how to analyse a company (vs just buying an ETF), this section is for you. Just before we dive in, there are a few basic terms you need to know. I’ll get into the specifics (like P/E ratios etc) in the next section.
Asset: An item of value owned by a company (e.g cash, real estate, intellectual property etc)
Liability: A company’s financial obligations (e.g loans, accounts payable, income taxes etc).
Balance Sheet: Where you can see the financial position of the business.
Market Cap: The total value of a company’s shares (share price x number of shares)
Book Value / Shareholder Equity: Book value is the total amount a company would be worth if it sold its assets and paid back all liabilities. Shareholder equity is very similar. It’s the amount of money that shareholders would be left with if all the company’s assets were liquidated, and all debt was paid off.
For example, if your home is worth $500,000 (asset) and you have a $300,000 home loan (liability), then you have $200,000 worth of equity.
How To Invest Like A Pro (Technical Jargon Explained)
In this section, I’m going to explain the criteria that the world’s best value investors use to analyse a company, along with the technical jargon for that specific criteria, explained in plain English. By the way, you don’t actually have to do these calculations (they are already done for you on most share analysis sites) but it’s important to understand them.
Gather your info.
When analysing a company, there are a few places to get information:
Yahoo Finance
Their free app is great for a ‘quick’ surface-level view of shares. It gives you a good ‘snapshot’ of the company’s performance, basic financials and analyst forecasts. Bear in mind though, the financials are only for the most recent year and not past years. I like to use Yahoo Finance for general daily activity, and quickly checking a company’s shares to see if it’s something I want to look further into.
10k / Annual Report
The company’s annual financial report is where you get the real info. For American companies, search Google for e.g ‘Starbucks 10k report’. For Australian companies, search Google for e.g ‘Commonwealth Bank annual report’. You also want to see the past 5 years of performance, so you may need to download several.
Simply Wall Street
This is a really great tool I found that helps you analyse a company quickly and easily. The best part is it compares it to its industry peers (which can be annoying to do manually). You get 5 free reports per month (which is usually enough).
Invest in what you know.
Stay away from things you don’t understand. It should be easy to understand how the company makes money (e.g it’s clear how McDonalds makes money), and whilst not compulsory, it’s even better if you pick companies with products you actually use. As a customer, you’ll have a more intimate knowledge of the business than outside investors. E.g if you love your Apple products and you’d never even consider switching to an Android (and all your friends think the same), that’s a good sign of a strong company.
The company is stable.
The company should have a consistent financial track record (5+ years) of:
Revenue / Sales
The amount of money a company brings in.
Net Profit / Net Income / Earnings
The total amount of money after all expenses, taxes and depreciation are subtracted from revenue. Imagine revenue is your salary, net income is what’s left after you’ve paid taxes and living expenses. Note: Gross margin and operating margin are different.
Return On Equity (ROE)
How well a company can turn your money into more money. It’s a company’s net income divided by shareholder equity. An ROE of 15-20% is generally considered good, but it’s best to compare to other companies in the same industry.
Dividend & Earnings Consistency
If they have consistently paid dividends and has a history of rising earnings for 5+ years, it shows it has stability even when the economy moves up and down. (Not all companies pay dividends, but if you’re a value investor you’re looking at ones that do).
Levered Free Cash Flow
The cash left over after expenses. It shows how well a company can generate cash, and whether they have enough to reward shareholders with dividends. If this is rising it could be due to revenue growth or cost reductions, which can be a good sign. When the share price is low and free cash flow is on the rise, it’s a good sign that earnings and share value will soon be heading up.
It has a competitive edge.
You want companies that have a strong competitive advantage (also known as a ‘moat’) and a high barrier to entry. E.g Coca Cola has such a strong brand, that any competitors have a hard time knocking them off the top.
The company has long term growth prospects.
Invest in companies with a strong future. There are a few ways to figure this out:
Economic Health
Is there anything in the economy that will affect the long-term value of a company? E.g as I’m writing this we are amongst the COVID-19 pandemic, and the travel and hospitality industries have been hammered. This could mean you can pick up some companies that have dropped substantially in the short term but will be fine in the long term, as long as they don’t go bust (more on this soon).
Industry Trends
Are there trends that will affect future earnings? E.g more people are shopping online now, so companies like Amazon have strong future potential. Artificial intelligence is becoming increasingly important, so companies with an AI department (e.g Google) will likely thrive. If you know the industry, this will be very helpful. You can find this by searching the web.
Earnings Projections
If the company’s earnings projections remain strong, this is a good sign. If they expect them to be lower, it could be a sign of earnings weakness. You can find this on their 10k report or Yahoo Finance.
You Could Own It Forever
Once you buy it, you’d be comfortable to not look at the share price for years. Characteristics of companies that last include selling a product people need (e.g McDonalds), sell a product that’s unique (e.g Apple), and has a brand loyalty that people are willing to pay for (e.g Coca Cola).
The company is conservatively financed.
It’s common to use debt to finance your business and grow faster, but a company with too much debt (especially short term debt) can be risky. There are two key metrics to look at:
Current Ratio
A company’s ability to repay short-term obligations. It compares its current assets (cash or assets that can be liquidated quickly) to its liabilities that must be paid in under a year. A ratio of 1.0 means it has an equal amount of current assets and liabilities. Between 1.5 and 3.0 is considered relatively ‘safe’.
If it’s higher, they may not be using their financing effectively. If it’s lower, they may be taking on debt so they can grow faster, but might have trouble repaying the debt on short notice if they needed to. This is very important to know during times of uncertainty because it shows whether a company has the cash to ‘weather the storm’. If they can’t, they risk going bankrupt.
Debt To Equity Ratio (D/E)
This shows how a company finances its assets. A low ratio means they use a lower amount of debt. A high ratio means they get most of their financing from debt. A D/E ratio of 1.5 (or 150%) means that for every dollar owned by shareholders, they owe $1.50 to creditors.
A high ratio indicates they may not be able to generate enough cash to repay their debt. A low ratio indicates they may not be taking advantage of increased profits that financial leverage may bring. As with other ratios, it varies by industry. Some industries with a lot of fixed and expensive assets (like construction or car manufacturing) typically have higher ratios. There’s no golden number, simply search the company’s industry average.
If a company has a ‘safe’ current ratio but its debt to equity ratio is very high, you might be confused (I certaintly was). This just means that their debt is mostly long-term liabilities (like property) that they don’t need to pay back any time soon. You can see this on the balance sheet where it says ‘Non-current liabilities’.
They Have Lots Of Customers
Beware of companies that rely on one customer (or a small handful) for most of its revenue. I actually own a company called Appen which I like for everything else, but 80% of their revenue comes from 5 big tech companies in the US. This presents a risk, and they have been hit hard during COVID as US is heavily affected and they are investing elsewhere for the timebeing.
The company is managed by vigilant leaders
The CEO and people running the company must be reliable and efficient. Looking at the company’s return on equity and return on assets are a good place to start, although you should also research the management team. Search Google to find out who the executive team is, and read their backgrounds and accomplishments.
Length Of Tenure
A good indicator is how long the CEO and top management has been serving the company. Jack Welch (one of the best managers of all time) was with General Electric for 20 years. If the company keeps changing CEOs and management team, that’s a red flag.
Operating Margin
A metric that’s useful to see management efficiency is the operating margin. Gross Margin is the total sales minus the direct costs of the product (e.g packaging or ingredients). Operating Margin is what’s leftover after they pay indirect costs like offices and advertising. This money leftover is used to pay investors and taxes.
Not Too Many Acquisitions
Beware of companies that acquire more than 2-3 companies a year. If they would rather buy shares of other companies than themselves, that is a hint that we as an investor should too.
It has low reinvestment costs.
A company that doesn’t have huge costs associated with growth. For example if they need a big factory or a coal mine, they are very expensive to create. A tech company like Google or Facebook has much lower expansion costs.
It’s available for a reasonable price.
The shares must be reasonably priced (this is what everyone wants to know, but the other factors are important because you want to buy value, not price). If it’s currently overvalued, keep it on your watch list and wait until it drops to a good value.
Earnings Per Share (EPS)
The amount of earnings left over for shareholders, divided by the total number of shares. Strong earnings generally result in the price moving up (and vice versa).
Price To Earnings Ratio (P/E)
Measures the share price compared to its earnings per share (EPS). It shows you how much investors are willing to pay for a company’s earnings. Basically, it tells you how cheap or expensive a share is.
A low P/E means it has low earnings growth prospects OR its undervalued. A high P/E means it currently has low earnings compared to its price but is expected to grow in the near future, OR it’s overvalued due to hype. A P/E ratio of 17 is usually considered ‘fair’ value but it’s important to compare ratios to similar businesses in that industry for a clear picture.
As always, context is important. E.g Tesla has a P/E high ratio which might look expensive, but the future expected growth is factored into it.
Note — I’m editing this blog in March 2021 and the P/E ratios are absolutely insane. They are the highest they’ve ever been across the entire market, so you won’t find many great companies at a P/E ratio of 17. And for full disclosure, I buy companies much higher than 17 if the rest makes sense.
Price To Book Ratio
Indicates how much investors are willing to pay for each dollar of a company’s net value. It shows investors the difference between the market value of the company and its book value (assets minus liabilities, aka the ‘net value’ of a company).
A P/B ratio of 1.0 means the shares are the same as its book value (reasonable)
A ratio of 0.5 means shares are one half of the book value (attractive).
Anything over 1.0 means it could be overvalued.
Anything under 1.0 means it could be undervalued.
Advanced: Price To Earnings Growth Ratio (PEG)
This compliments the P/E ratio to help you figure out whether a share is undervalued. In their annual report, the company will put a ‘growth projection’ for how they think they will perform. The PEG divides the P/E ratio by the projected earnings growth. E.g if a share had a P/E ratio of 15 and projected earnings of 15%, the PEG ratio is 1.
If it has a PEG over 1, it means the market expects more growth than the company’s projections, which means the shares could be overvalued.
If it has a PEG under 1, it means the market predicts less than the company’s projections, and it could be undervalued.
Never use one statistic by itself to give you the answer. All of these need to be considered among the context / big picture of the other statistics of the company, and compared to other companies in the same industry.
It’s Your Turn!
Phew! We covered a lot in this article — if there are any pieces you don’t understand, do further research on Google and YouTube until it makes sense (Daniel Pronk has some great videos on financial statements).
Theory is one thing, but getting real-world experience and actually doing it is another. Practice analysing some companies you like and if it makes financial sense for you, you can get started with a small amount. If you have any questions you can DM me on Instagram @mitchills and I wish you all the best!
PS — I’ll soon be launching a step-by-step breakdown of a real-life example of a company I’m analysing. Keep an eye out for that, where you can see all of this put into action!
