Are you ready to start investing in the Sri Lankan stock market? Here’s everything you need to know about buying your first stock.
If you have no idea about what the Stock market is or what Colombo Stock Exchange is, I suggest you read our guide on How to make money in Sri Lankan stock market which explains the basics. If you want to know how the stock market and its components work, start reading the Basics of Sri Lankan share market: The big picture. If you want to know how you can select a stockbroker, read our post on How to select a stockbroker in Sri Lanka.
Take your time. I won’t go anywhere. Done? Great! Now you’re ready to pick your first stock. Here’s everything you need to know about picking your first stock in the Colombo Stock Exchange.
You don’t have to start with a Rs.1 million. You can start with something as simple as Rs. 1,000 to Rs. 10,000. Your goal is not to make money in the beginning. Your goal is to learn how the market works. So starting small is completely fine. After all, it’s your money.
Don’t expect miracles in the beginning
Investing in the stock market is not for investors who are trying to make a quick buck. It’s a long-term gig. You may not see huge equity gains or dividend earnings pouring into your account in the beginning. That’s how it works. Your job is to understand how stocks can work for you in the long-term.
Dummy definition of investing in stocks
If I can really dumb it down, this is what stock investing looks like. You’re buying stocks from a company hoping that the company would perform well in the future. If the company performs well, the value of your stocks will climb. So the simplest strategy is, buying stocks from great companies and holding them until they perform well. When you look at it like that, it sounds super simple, right? Well, it actually is. But how do you know if a company will grow in the future? That’s what this post is all about. If you look at a company, there are so many variables affecting the performance and it will be impossible to develop a comprehensive formula to capture all the factors.
The bottom line is there is no one method or any formula to pick the best stock.
Broadly, there are two approaches to analyzing a stock. One is the fundamental approach and the other one is the technical approach. Don’t get taken back by these terminologies. It’s quite simple once you get a hold of it.
1. Fundamental approach
There are so many things that can affect the performance of a company. If we take a Tea Plantation company as an example, the weather can impact the performance. If the labors demand for higher salaries, profits can go down. If the company hires a new CEO who has an excellent track record; she can turn around the company.
Simply put, fundamental analysis will look at a company’s financial, non-financial factors and things like what’s happening in the economy, industry dynamics etc.
The ultimate goal of fundamental analysis is to find the value of a stock which can then be compared with the current market price. Then you can decide whether the company is overvalued, undervalued or fairly priced. Let’s say the share is currently trading at Rs. 100 and through your fundamental analysis you figure out that the actual value of the share is Rs. 120. Then we can say that the share is undervalued in the market.
Warren Buffet, well-known for using the fundamental approach looks at following things when analyzing a company.
- Company’s performance – He looks whether a company has performed well in the past and that the company has had an acceptable level of return on equity (return on equity is the net income earned as a percentage of shareholders’ equity.)
- Amount of debt the company has taken – Higher the debt the company has, it’s going to be a concern as to how it will repay the debt.
- Profit margins – How the profit margin has been over the past and looking at a longer period will let you understand if there were any short-term trends.
- The uniqueness of the company’s product – If the company has a product that cannot be bought from a competing company, then it will provide the company an edge to perform well.
- The discount at which the shares are trading – This determines how much profitable your decision will be. Let’s look at stock A, which is currently trading at Rs. 100 and your estimated fundamental value is Rs. 130. Stock B is currently trading at Rs. 100 and the estimated fundamental value is Rs. 105. Stock A has more potential to make you more gains.
- Investment horizon – This is basically how long you are going to hold on to the investment. Warren Buffet always chooses stocks with long-term growth prospects and doesn’t sell the stock to realize short-term gains.
Let’s look at how you can do this practically in our next post.
2. Technical approach
The common goal in both fundamental and technical approach is figuring out whether the stock is mispriced (overvalued, undervalued) in the market. But in technical analysis, we are not going to look are fundamental factors, but rather the share’s trading statistics which basically includes the share’s historical price and volume related data.
The underlying assumption behind technical analysis is that the current market price reflects all the available information in the market and the price should be fair value. So, the historic price and volume movement is analyzed and the future trend is determined. Based on this, you can make a call on whether to buy or sell a share and profit from the decision. There are several graphs and analytical tools used to analyze the attractiveness of the stock.
Mostly every stockbroker in Sri Lanka has online tools that you can use to understand how technical analysis works. To sum things up, both approaches can be useful in analyzing a stock and complements each other to overcome their drawbacks.
That’s it for the basics of picking up your first stock. Now don’t over think these concepts and try to analyze 100 stocks before buying your first stock. You can always ask about these things from your stockbroker. After all, that’s their job to make the best use of them.
Remember that you’re going to make mistakes on the way and that’s also a part of the journey. Think of yourself as a student when picking your first stock. Ask as many questions from your stockbroker as you can. See how your stock has performed over the time. Make some mistakes and learn from them. That’s the best way to go about it.
That’s it for the basics of picking your first stock. We will dive into these concepts in our next post. Till then, happy investing.
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