Sunday, July 17, 2011

Your First Investment in Stock

I have friends who ask me, how do I learn how to invest in stock market. For a start, I don't have a financial degree nor it is my profession. Well....maybe part time yea, since I am an investor now. In a way (no disrespect to business school), I think its is good because I happen to know that thing that were taught there weren't exactly helpful if not harmful - think Wall Street and Efficient Market Theory. Of course there are better school as well. Just that I would most likely fall into one of those teachings.

How I get started is a long story but I do have economics background picked up when I was younger. My knowledge in stock investment is through reading, reading and reading....and reading. It can be books, blogs, forums, financial sites or anything. Books of course have been the most helpful. I think for starters, the first and most important investment to make in stock is the investment in yourself. 

So here, I have three books which you can pick to invest in yourself and they are for value investing. Why value investing? To make it short, you'll be investing in the business and its fundamentals not the price - which makes more sense. These are the quickest way that I could think of.

The Warren Buffett Way - Robert Hagstrom
I always recommend this as the first book for everyone who just started. In fact this is the book that I read when I have no idea at all what is a stock market! So it is a book The book have a short history of you know who, how he got started to become who he is today. It provides the overall strategy for investing base on the 4 tenets:

  • Business tenets - Business economics of a business: the competitive advantage or moats
  • Management tenets - Which tells the honesty of the management and whether a management decision makes sense
  • Financial tenets - This tells the financial of a company. Is the balance sheet strong? Are they making profits?
  • Valuation tenets - How much would you pay for the business. The also also provides a sample of a Discounted Cash Flow Valuation. But I would recommend DCF table in wikipedia as it is more simplified and clearer. One note though, you might end up with over valuation if you follow his style, there is another book on valuation I'll show later.
It also mention about the concept of margin of safety which is an important tool that you would need.

The Five Rules for Successful Stock Investing - Pat Dorsey
This is a all in one book. It covers the first 3 tenets above in better details and only cost you about RM56 if you were to purchase it in Malaysia. This book discusses the economic moats for every sector or industry there is in the business world. You'll be able to identify great, good and ugly businesses after reading this. Although I would recommend The Little Book that Builds Wealth by similar author for moats, this book itself is good enough if you are a little bit tight on budget. 

Accounting is the language of business and investing. You won't be able to do this successfully if you don't understand the language. There are basically 3 financial statements: Income Statement, Balance Sheet and Cash Flow Statement. These are the 3 statements that you need to understand before you can start. And to be honest, I am sceptical if people are able to manage their own personal finance without understanding these 3 statements. This book could provide you enough knowledge that you need. It even discusses the debatable discount rate - if you know what I mean. I have to say I agree with him.

It also points you some red flags that you might want to take note on the management. It definitely doesn't cover all as there are infinite ways for financial shenanigans. But do not let this scares you away because I bet you know who to trust and who doesn't. Understanding the financial language and margin of safety will give you good enough protection already. 

Value Investing: from Graham to Buffett and Beyond - Bruce Greenwald
This is one of the best book on valuation so far. It defines the concept of value investing. It groups value investing into 3 types of valuations:

  • Assets Valuation - Which is on the balance sheet - aka the Cigar Butt style. It offers the least risk and of course huge returns. It is the safest bet of all. But, you have to be really good and extremely familiar with the business assets because there is where the value lies. I am afraid, this is better suited for full-time investor mainly for 2 reasons: It is very difficult to find such investment or assets that is selling below its hard value. And you need a team to identify its value quickly. Few of the best known investor in this style is Benjamin Graham and Seth Klarman.
  • Earnings Power Value - This is where we find the intrinsic value of a business. Buffett once said "...the value of a business is how much the business could generate over a period of time..". This has a little more risk. However it could be greatly minimized by picking businesses which wide moats.
  • Earnings Power + Growth Value - This is the riskiest of all. Although I have to admit that I use to this kind of valuation and in fact make great trades with this. But I guess I was a little lucky. I started in 2008, and it is difficult to get punished by such market condition. Never pay for growth unless you are very sure what it looks like.
So there you have it. These 3 books could give you enough arsenal to start in the stock market. Of course one might ask, these are Americans books which focus on US stocks. Okay, this is not a book on stock tips but rather educational. Except for taxes and laws, most of them are applicable to any businesses in the world. 

There are others books that you might be interested as well:
The Intelligent Investor - Ben Graham:  Dubbed as the bible of investing. It doesn't only cover stock but other investment types as well such as ETF and mutual funds. And the concept of margin of safety. A must read.
Common Stocks Uncommon Profits - Phil Fisher: Great book on management and "di-worsify". Also a must read.
Security Analysis: Ben Graham: If you are full-time or hardcore stock investor. This is a must read. In fact, any new employee in Uncle Tan's firm have to read this before they start anything. 

Of course, it would guarantee you success. Temperament is important as well but I don't have any remedy for that. That you would have to control it yourself. I'll leave you with this wise words from Sun Tzu "Know yourself and know the enemy, and you won't fear any battles"

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