So you’ve probably heard of the saying “make money work harder for you”?
You want to start generating passive income through stock investing…
Or grow your investment portfolio for retirement needs.
You’re eager to begin but it seems like a daunting task, there is so much information out there and you don’t have any idea how or where to start?
Investing may seem overwhelming at first, the financial jargon and complexity of interpreting financial statements can be a huge obstacle for beginners. I was in your shoe when I started out my investing journey, in my early days I read a lot of books on investing and trading and learnt the different school of thoughts. I spent hundreds of hours reading articles, research papers and financial statements over the years and I hope to share this with you to shorten your learning curve.
I will walk you through the basic concepts and terminologies of stock investing and equip you with the knowledge to kick-start your investing journey.
Now, let’s begin with an old folk story…
Long ago, when an inventor of chess introduced the game to a king, the king was so impressed by the new game that he wanted to reward the inventor and that he will fulfil the inventor’s request.
The inventor then replied, “My wish is simple. I only wish for one grain of rice for the first square of the chessboard, two grains for the second square, four grains for the third square, eight for the fourth square and doubled the grains of rice for each subsequent square till the 64th.”
Baffled and amused by his request, the king happily agreed.
After a week when the treasurer was still not done, the king asked what the problem was. The treasurer replied, “Well it took me a while to run the calculations but we don’t have enough rice in the kingdom or even on the planet to fulfil his request!”. The treasurer informed him that the reward would add up to a huge number—far greater than all the rice that could possibly be produced in many centuries!
The total number of grains equals 18,446,744,073,709,551,615 – much higher than what most intuitively expect!
This story explains the power of compounded interest. Now think about this, “Would you rather have a million dollars or the sum of a penny doubled every day for a month?”.
Have you heard of the eighth wonder of the world?
Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.”
Compound interest is the addition of interest to the principal sum of a deposit, or in other words, interest on interest.
Here’s an example of compound interest/returns on $10,000 principal over a 10 year period:
|1||$ 10,200.00||$ 10,500.00||$ 11,000.00|
|2||$ 10,404.00||$ 11,025.00||$ 12,100.00|
|3||$ 10,612.08||$ 11,576.25||$ 13,310.00|
|4||$ 10,824.32||$ 12,155.06||$ 14,641.00|
|5||$ 11,040.81||$ 12,762.82||$ 16,105.10|
|6||$ 11,261.62||$ 13,400.96||$ 17,715.61|
|7||$ 11,486.86||$ 14,071.00||$ 19,487.17|
|8||$ 11,716.59||$ 14,774.55||$ 21,435.89|
|9||$ 11,950.93||$ 15,513.28||$ 23,579.48|
|10||$ 12,189.94||$ 16,288.95||$ 25,937.42|
2 fundamental factors that we can learn from this…
One, is that compounding takes time, we should invest with a long-term perspective and returns will snowball over time. Hence the earlier you start investing, the better off you will be.
Two, achieving higher than average returns will help you reach your financial goals faster. Compounding at 10% per year as compared to 2% results in double the ending balance.
Now that we have discussed the basics, let’s move on…
In general, we want to invest in assets that historically outperforms the rate of inflation – simply because inflation erodes one’s purchasing power. Today, we have a variety of options to grow our money. We can invest in properties, bonds, investment-linked policies, unit trust, commodities and foreign currencies. My ‘weapon of choice’ are stocks, this shall be the focus of this article…
So what are stocks?
A stock represents a share in the ownership of a company, it gives the owner rights to vote in shareholder meetings.
The more shares or stocks you own, your voting power increases. Some investors will own shares large enough to take control of the company or influence the decisions of broad members. Collectively, shareholders have the power to remove management who are under-performing such as the recent case with International Healthway Corp (IHC).
As an owner of shares in the company, you are entitled to receive dividends if the management declares to distribute them.
If the company is profitable or performing well, the management may choose to distribute dividends as a reward for shareholder loyalty. Conversely, the management may choose to cut dividends or not distribute at all if performance is poor.
Types of shares
I bet you didn’t know that stocks are divided into two classes…
Common Stocks represents a share in the ownership of a company and a claim on a portion of that company’s net profits. Common stockholders have voting rights to elect the board of directors. As partial owners, common stockholders make the highest returns among all investors in the company but also carries significant risk. If a company goes bankrupt, any payment received will precede the creditors, bondholders and preferred shareholders before common stockholders.
Preferred Stocks do not carry voting rights, in return, it gives stockholders a higher claim on the company’s assets and earnings. Preferred stock combines features of debt, in that it pays fixed dividends, and equity, in that it has the potential to appreciate in price.
Dividends vs Capital Gains
As an investor, we can make money from stocks through…
Dividends are money paid by the company to its shareholders out of it profits or cash reserves. Companies issue dividends if there is no requirement to hold excess cash, this may be due to a sale of an asset or higher than expected operating cash flows.
Capital gains refer to the positive difference between your purchase price and current selling price of the stock. This can very easily lead to speculation without a proper investing mindset.
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Investing vs Speculation, what is the difference?
“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” — Ben Graham
The idea of making ‘fast money’ lures many to the stock markets and predicting short-term outcomes is high-risk. Speculation can lead to detrimental effects on one’s psychology and financial solvency hence should be avoided at all cost. An individual who buys or sells stocks with little or no research done to understand the underlying business is said to be speculating. Obviously, the topic itself can be debated at length but this is not our objective here, so let me summarise the factors that defines a true investor:
Clear objective – be clear on what you want to achieve; are you investing for retirement? what is your investing focus? capital gains, dividends or both? are you investing for value or growth?
Reasonable expectations – everyone wants to achieve the highest possible returns in the shortest amount of time, nothing wrong with that. However, if you are expecting 500% gain in 6 months, it will lead you to take excessive risk. The best investors in the world know that investing is a long-term game, they understand the power of compounding returns and use it to their advantage.
Sound investment framework – good investors use frameworks to identify investment opportunities, this ensures that investment ideas run through a selection process with guidelines based on sound principles. For example, an investor who adopts a value approach may identify investment opportunities based on simple valuation metrics such as Price to book value (P/B) or Price to Earnings (P/E) and etc.
The key is to view stocks as partial ownership of businesses and to view its management as partners if you begin with that in mind, investing becomes rational and enriching.
Most companies are categorised in terms of market value and a proxy to that is the Market Capitalisation which refers to the current share price multiplied by the company’s shares outstanding. A company may fall into the following 4 categories:
Large Cap (Bluechip) – Refers to companies with market value of more than $10 billion. In smaller markets like Singapore, a company with $5 billion market value can be considered a Large cap.
Mid Cap – Refers to companies with a market value in the range of $2 – $5 billion ( $0.5 – $1 billion in Singapore).
Small Cap – Refers to companies with a market value in the range of $0.5 – $1 billion ($100 – $500 million in Singapore).
Micro Cap (Pennystocks) – Refers to companies with market value lower than $500 million (below $100 million in Singapore).
You also classify companies into these 6 categories: Slow-growers, Stalwarts, Fast-growers, Cyclicals, Turnarounds and Asset plays.
Slow growers: Large and mature companies growing only marginally faster or at pace with the domestic economy, but paying regular dividends.
Stalwarts: Large companies have the potential for growth into new markets or new products, with annual earnings growth rates of around 10% – 12%.
Fast-Growers: Small, aggressive and innovative new firms with earnings growth of 20% – 30% annually.
Cyclicals: Companies in which revenue and profits are highly correlated with the global economic cycle (e.g. auto, airline and commodities sector).
Turnarounds: Loss-making or underperforming companies that are recovering from a slump.
Asset-plays: Companies that are trading at discount to its tangible assets.
Fundamentals or Technicals, which is better?
I’ve probably heard this question a thousand times…
Having been in both camps, I started out with technicals but over the years I gravitate towards fundamentals. Why you may ask?
I guess as a beginner, I viewed the markets as binary. Either it goes up or down, so why bother learning about everything else right? So, I started out with a short-term trader mindset and technical analysis appealed to me. Being a short-term trader, I always got involved with market ‘noise’ and trading along the flow of markets. The ‘high’ frequency of trades and constant ‘monitoring’ of markets added with the stress of managing multiple short-term positions were mentally taxing and it took a toll on me, I realised that it was not sustainable.
Eventually, I moved on to taking longer-term positions which require more research done on fundamental analysis and understanding businesses. As a fundamental investor, I now focus on long-term performance, as a result, I am much calmer and able to manage my portfolio with less stress.
So what are the components of fundamental research? What factors do fundamental investors look out for?
There are 2 main approaches to fundamental research; Growth or Value.
Growth investors attempt to capture secular trends and predict fast-growing companies in fast-growing industries. Growth stocks are companies with the potential to expand its market share into new markets or new products.
Contrary to that, value investors seek to buy stocks that are trading below its intrinsic value. A company can be undervalued for many reasons; an underperforming management, declining economy or industry prospects or declining profits.
So why would value investors buy stocks that are performing poorly?
The market tends to overreact to pessimism and this drives stock prices to bargain levels. Value investors will then attempt to value the company from its assets or projected returns of future cash flows and buy its stock at a discount to its intrinsic worth. Hence, value investors rarely follow the crowd. If anything they tend to invest against the market, which is why they are sometimes referred to as contrarian investors.
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Growth vs Value?
I don’t believe that one is better than the other, its a matter of finding a method that suits you best and to your advantage. It is not uncommon for investors to adopt a hybrid approach, combining the best of both worlds in a value-growth method. There are many legendary investors from both camps; Peter Lynch adopts the growth method while Warren Buffett prefers value.
Investing is about understanding businesses and industries, it is crucial for investors to approach investing in a business-like manner and avoid speculating. The difference is simple: an investor looks at a stock as part of a business and the stockholder as the owner of the business, while the speculator views himself as playing with expensive pieces of paper, with no intrinsic value. For the speculator, value is only determined by what someone will pay for the asset.
To me, value investing makes the most sense and is in-line with my personality and beliefs. I have spent a considerable amount of time studying the topic, and I have penned out my thoughts on my approach to investing and the principles that have guided me over the years.
Overview of Financial Statements
If you are not finance or accounting trained, interpreting financial statements can be intimidating. However, if you can understand the basic concepts of each statement and its purpose, analysing and understanding businesses becomes a lot easier.
The 3 fundamental statements are:
Income Statement – to check the profitability and expenses of the company. As investors, we want to know if the company is profitable. Some of the key data to look out for are revenues, profit margins, operating expenses and net profits. A single series of data only tells half of the picture. You need to compare these data with previous quarters or years to identify trends such growing earnings, increasing operating cost or compare income statement against its peers to see how profitable it is on industry level.
Balance Sheet – to check the financial health of the company. The balance sheet is where you will find assets and liabilities owned by the company. Assets are categorised as fixed and current, the former refers to tangible and physical assets such as buildings, land, machinery and etc, while the latter refers to assets that are highly liquid or can be converted to cash within a year. Examples: Cash, short-term investments and accounts receivable.
Cash Flow Statement – shows the cash receipts and cash payments through the financial year. The cash flow statement records the company’s operating, financial and investing cash flow. To put it simply, this statement records cash flow going in and out of the business.
Open a brokerage account in Singapore
Now that you’ve learnt the basics, it is time to open a brokerage account.
There are 2 accounts that are required before you can buy your first stock:
Brokerage account with a stock brokerage firm
Via the brokerage firm, your orders will be routed to the stock exchange where they will be placed or executed to buy or sell in SGX listed securities. All brokerage firms will provide an online trading account to facilitate order submissions. Here is a list of all stock brokerage firms in Singapore and its brokerage fees:
|Brokerage fees (based on contract amount)|
|Minimum Fees||<$50k||$50k to $100k||>$100k|
|Lim and Tan||$25||0.28%||0.22%||0.18%|
|Maybank Kim Eng||$25||0.28%||0.22%||0.18%|
|Phillip Securities (POEMS)||$25||0.28%||0.22%||0.18%|
|SAXO Capital Markets||$15||0.12%||0.12%||0.12%|
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- A step by step guide on how you can start investing with less than $10,000.
- Macroeconomic insights on markets and deep value analysis.
- Simple and easy to use template for stocks valuation.
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Central Depository (CDP) account
Before you sign up for a trading account, it is better to create a CDP account first as this will be required to link up your trading account with the CDP account. A CDP account is a storage account to deposit stocks and other listed securities you own. Click here to sign up for CDP account.
Stock investing can be rewarding if done right. To be a successful investor, one needs to have a clear financial goal, some invest for retirement while others invest to generate a second source of income. Many beginners often start with unrealistic expectations such as trying to quadruple their investments in a short time span, that mentality often leads to serious financial setback. It is important for investors to adopt a long-term investing mindset and reap the benefits of compounding returns over time. Investing is a life-long learning process; on a final note, have a solid investment framework and continue to develop knowledge to gain a competitive edge over the crowd.
Next topic: What is Deep Value investing?
How to create your second stream of income through Dividend Investing – beginners guide.
3 Quick & Simple Ways to Value a Stock
5 Ratios to Determine Financial Health of a Business
3 Easy Steps to create Deep value Investing Framework
Diversification vs Concentration: The Great Debate
6 Catalyst to look for in Undervalued Stocks
5 simple steps to review your portfolio.
Introduction To Fundamental Analysis
IPO Basics: What Is An IPO?
Exchange-Traded Funds (ETFs)
Understanding the Income Statement
Reading the Balance Sheet
5 must-have metrics for value investors
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