In this guide, I will explain the basics of investing in the Stock Market in simple words without assuming anything. Stock investing is not and should not be presented as rocket science. To become a successful investor you don’t have to be a math genius. You only need to understand a few things well and keep emotions away from eroding your investment decisions.

This guide is for people who want to invest their money in great companies and be rewarded for doing so. A real investor invests in a great company today because he thinks it will be a great company after ten or twenty years. Here, I want to teach you a long-term Warren Buffett approach to investing which will make your money grow slowly but surely.

If you want to make money in the Stock Market and turn from broke to rich this year, this guide is not for you. If you want to become a stock day trader buying stocks in the morning and dumping them in the afternoon, this is not the right guide for you either. There are other resources out there that promise to make you a successful day trader. In that case, I wish you good luck with that because you’ll indeed need lots of it.

I know I keep mentioning Warren Buffett throughout this guide. In fact, I could have equally titled this guide “Invest in Stocks ala Warren Buffett”. The reason is simple. Warren Buffett is the most successful investor. My manager in the Equity Derivatives Department at Barclays Capital said once to me: “Can you find the one authority with a proven experience and consistent results? Follow them and ignore everybody else. This is how you’ll get success.” We were talking about stock investing and he meant Warren Buffett.

My interest in the Stock Market arose in university when I was studying mathematics and economics. I was so excited about things like Stochastic Analysis, Time Series and Trading. Later on, I realised that advanced mathematics is not only unnecessary for achieving investing success but can even turn dangerous. Look at the 2008-2009 global crisis when math geniuses plunged the world’s banks into a catastrophe with their complex financial instruments.

To see your money grow you don’t have to beat the market. You don’t need a secret mathematical formula, inside information, or lots of money to move the market with your positions. To see your money grow you can just grow along with the market when having a long-term horizon. To see your money grow, you need to invest in companies that you understand, companies with good management, companies with products that people love and will continue to love in the future. If you can also buy the stock of these companies when everyone else is fearful and pessimistic (in a bear market – when stock prices are going down) you’re bound to achieve success in the stock market.

But hold on a second. Why invest in stocks or invest anyway? People around you keep saying: “You need to have savings, lots of savings! Work hard and save!”

The problem is that governments can print money whenever they want. Have the banks collapsed? No problem, let’s throw some money into the economy! Any time, whether we’re going through a crisis or not, central banks can switch the printers on. And when they do so, your cash savings are losing their purchasing power.

You’re still paying your mortgage every month since 2008. You haven’t stopped, have you? The four major Central Banks (US, UK, ECB, Japan) though have thrown $9 trillion dollars into the economy since 2008. Should one feel proud when they’re getting 2% on their savings and the inflation is running at 5%? That’s not an investment, is it?

You should have your money to work for you instead of you working for it. You should be investing in active assets that can run faster than the inflation. I’m not saying get all your cash from the bank and throw it to the stock market. Some cash safety is essential as anything can change from minute to minute, ie. you lose your job, your kid is born, etc. However, it’s a crime to have too much cash sitting in the bank.

How can you have your money work for you? By investing it. Investing it in the stock market, in real estate, land, rental properties, an online business, things that provide cash flow. Invest in yourself! Invest in knowledge, new skills, gym, mentors, books. Long-term all this is guaranteed to give you more than 2% that the bank is giving your right now.

In this guide, we’re talking about investing in stocks. When you buy a company’s stocks you become one of the owners of that company. The company makes profits, you get dividends, ie. a share of those profits.

It surprises me when I hear people say “I want to invest in the stock market” and they don’t know what dividends are. Dividends? What’s that? I’m gonna buy and hopefully, when it goes up, I’m gonna sell.

The reason somebody invests in a company is not that its stock is going to go up. You invest in a company because you believe it will make profits. It makes profits, you make profits since you own its stock. If the company keeps making profits, of course you’ll see its share price go up. The reason I’m saying all this is because I want you to focus on the company and its growth rather than the share price. Warren Buffett first reads a ton of reports about the company and only in the end checks the share price to see if it’s overpriced or undervalued. If it’s underpriced, he invests in the company.

Enough of introduction. Let’s get started. I’m planning to be updating this guide regularly with more and more content being inspired by your questions and comments. This is going to be a forever growing resource, so please subscribe to this list below to get notified of all the future updates.

The Basics of Stock Investing

First of all, what does stock mean? Stocks are ownership certificates issued by companies. So, “if you own stocks”, it means you hold a portion of ownership in one or more companies. In other words, you are one of the owners among those who own stocks of these companies.

We use the term stock to refer to ownership of more than one companies. If you own ownership certificates of only one company, you can use the term share, ie. “I own Apple shares”. If you own shares of Apple, you are one of Apple shareholders, ie. you invested in Apple and you have been granted a portion of Apple’s ownership. Another term for stocks is equities. So, this guide could have been titled Investing in Equities.

You have probably heard someone asking “Invest in Equities or Bonds?”. Bonds are issued by governments or corporations who are looking for funding (financing). A corporation who sells the bonds is obliged to pay interest payments to the buyer of the bond (the lender) plus the whole face value/ notional value of the bond at its maturity date. So, let’s say you buy a government bond with face value $1000, 5% annual interest rate (coupon rate) and maturity 10 years. This means you give the government $1000 and thereafter you receive 5% * $1000 = $50 every year and after 10 years the government will also pay you back the whole amount of $1000 that you invested (the face value of the bond).

So, the story is as follows. At some point in its life a private company decides to raise money in order to grow. Maybe the company wants to hire more employees, expand its operations, create new product lines, open offices abroad, etc. One way is to go to a bank and get a fat loan. More often than not, this is not a good idea as banks charge high interests on loans. A better way to raise capital is through bonds (debt) but again the company may have already issued bonds and wants to grow without taking on more debt. This is where equity financing and stocks come to offer another way to raise money. Companies give away a portion of ownership to the public by issuing shares, ie. ownership certificates as we said earlier. So, the company from private becomes public. This way the company compromises some of its future earnings which will go to the shareholders but at least it can grow without more debt burden.

To make an analogy here, sometimes it’s more efficient to invite a close friend to become a partner in your small business and sharing the business profits with him in the future rather than borrowing money from him and repaying him later. A partnership can accelerate results as more people are working towards a common goal (to grow the business). At the same time, a partnership has disadvantages as you are no longer the sole owner who decides the fate and strategy of the business.

Equities and Bonds are the most common financial securities. A security is a tradable financial instrument that holds a monetary value. For example, stocks are tradable on a Stock Exchange and hold a value – price based on laws of offer and demand.

A Stock Exchange is where the buyers meet the sellers and stocks change hands. The most famous Stock Exchange is the New York Stock Exchange (NYSE). Stocks are traded on a Stock Exchange after the company offers them to some initial public investors through a process called Initial Public Offering (IPO).

The Initial Public Offering is done with the help of an investment bank which works out the details of the deal and makes sure certain conditions are met in the company, ie. how much money will be raised, how many shares will be issued, the price of one share, etc. After the initial purchase of the company shares (primary market) the people who own the shares can sell these shares in a Stock Exchange (secondary market).

So, investors like you and me can purchase these shares in the Stock Market and become owners of that company. Now you understand that the whole purpose of buying a company’s shares is the desire to become part of a company because you have a genuine interest in the company, believe in the company and you want to see it grow in the future. If that’s the case, the person who buys the company’s shares is called an investor.

On the other hand, in the Stock Market, you also have people who buy and sell stocks because they are driven by short-term profits without really caring about the long-term fate of a company. These people are called speculators, ie. they only speculate on the price of the stocks. Perhaps, speculators are not doing the best thing for themselves but they are useful to a Stock Market as they provide liquidity, a high volume of activity in the market. The more the people who participate in a market, the more the chances of a buyer finding the right seller and vice versa.

In a Stock Market, you can buy stocks of different companies. But what do we mean when we say that the Stock Market is going down? For this purpose, an index helps investors to summarise and get a broad idea of the overall performance of market or economy. For example, the S&P 500 reflects the performance of 505 large US companies. The Dow Jones Industrial Average Index (DOW) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq, an electronic stock exchange that allows people to trade stocks on a speedy, computerised, reliable system. Shares of companies like Apple, Intel, Microsoft are traded on Nasdaq. The term Nasdaq can also refer to an index though, the Nasdaq Composite Index, which is an index like Dow Jones Average and S&P 500. The Nasdaq is heavily weighted towards information technology companies.

Invest in Stocks like Warren Buffett

Warren Buffett is a well-known American investor who serves as the chairman and CEO of Berkshire Hathaway. He is number #3 in the Forbes list of the wealthiest people with a net worth of more than $90bn. If you follow him on the news and read his letters to the shareholders of Berkshire Hathaway, you’ll realise that this guy does love his job more than the money itself. He’s been living in the same house for years, he doesn’t drive luxury cars, etc. Do you want to have a look at his modest property? Check here. When they asked him why you haven’t moved to a more extravagant house, he answered: “I’m happy there. I’d move if I thought I’d be happier someplace else.”

Buffett has a long-term approach to investing. When he buys a company’s stock is because he wants to be a contributor to the company’s success and grow with it long term. And of course he can contribute and play an active role when his positions are huge in the companies that he invests.

“If you can’t afford not to look at a company’s share price every day, you shouldn’t invest in that company”, Buffett says. Remember, a speculator uses stock as a vehicle. A speculator jumps on this vehicle and is ready to dump it any time. The only thing that drives him is quick short-term gains. Warren Buffett is not that type of player. When he buys a company, he’s committed to it for more than ten or fifteen years.

Buffett is not the type of investment manager who is secretive about his holdings and investments. The openness, clarity and transparency have been the key to Berkshire Hathaway success. Buffett has done so much to educate both his shareholders and the public about the right approach to investing.

He often encourages beginner investors who don’t want to spend much time managing their portfolios to invest in a cheap S&P 500 index fund. That makes sense for two reasons: Passive index funds are inexpensive and aren’t tied to the success of one single company. “The trick is not to pick the right company,” Buffett says. “The trick is to essentially buy all the big companies through the S&P 500 and to do it consistently.”

Individual stocks also cost more to manage, which means advisors take a larger chunk of your earnings. “Costs really matter in investments,” Buffett says. “If returns are going to be 7 or 8 percent and you’re paying 1 percent for fees, that makes an enormous difference in how much money you’re going to have in retirement.” In terms of fund management fees, you shouldn’t be paying more than 0.5%.

By investing in a cheap index fund and having a long-term investment horizon, the chances are that your investment will outperform the returns of most investment managers who actively manage the money of their clients seeking for a superior return.

Has Buffett made his huge wealth by investing in an S&P index fund? No. The reason is that Buffett has the expertise, tools, and capital to engage in more sophisticated investment decisions which can deliver better results. How does he achieve that? By reading tons of reports and doing thorough research to pick the best companies with the best growth prospects. A great company whose stock is also underpriced is Buffett’s typical bet. This investing technique is called value investing.

In other words, Buffett is interested in the real value of a company. To find the real value he crunches the company’s numbers on quarterly and annual reports. He’s looking at numbers like net income (earnings or profit, ie. revenues minus costs like interest on borrowing, taxes, etc.), capital structure (how a company has raised money, how much it has borrowed and at what price), cash flow (money coming in and out of the business every month), the competition, the company’s competitive advantage, etc.

Buffett aims to come up with an estimation of how much he would be willing to pay to buy the entire company today. If that price is greater than the price at which the market (other investors) values that company, he is happy to invest in the company.

So, again, does an average inexperienced investor has the time, desire, experience, team, capital, tools to do what Buffett does? Not, of course. Just like Buffett can’t design a house from scratch since he’s not an architect like you, you can’t spot the winner stocks like Buffett! That’s why he suggests that an average investor would be better by investing in a cheap passive index fund.

Well, let’s be more precise here. You don’t just buy once and wait to see what happens thirty years later. You invest more every month or whenever you have extra money that you don’t need in the short term. Buffett says: “Buy consistently an S&P 500 through thick and thin, and especially thin”. That means you should consistently buy more and more stocks over time without worrying about the prices. Well, of course you should be looking to buy more in a bear market, ie. when prices are going down (“buy thin”).

It’s crazy but the majority of the investors do the exact opposite, ie. they rush to sell when the prices have hit bottom! Don’t do what everybody does! You should be buying more when the market has lost value in the short term. That’s how an intelligent investor makes fortunes.

What does “investing in a cheap fund mean”?. That means the fees you pay for your investment should be as low as possible. You may think that a 1% or 2% fee on the value of your portfolio is not that bad. You think: “These guys are good and they’re gonna make me money anyway so they deserve their 2%!” However, the fees make a huge difference in your returns over a 30 year period if you’re saving for your retirement. I did some basic number crunching and I assumed that you invest 6K every year for 30 years assuming an index annual return of 6%. On the picture below you can see what you get when you pay fees 0.5%, 1% and 1.3%. A small difference in the fee does make a huge difference over a long period of time .

Buffett believes in the US economy and advises people to invest in the biggest US companies, ie. S&P 500. Now, a reasonable investor would argue: “Why one should purposely avoid half of the world’s market cap (non-US), especially when you can buy cheap foreign equity index funds?” There may be a good reason to have a fear of emerging markets, but the developed markets make up 80% of the foreign stock market, and there’s no reason to think that Japan, Australia, Switzerland, etc. are any worse off than the US. A counter-argument would be that in the modern world we are seeing an increasing market correlation between the US economy and the world economy. So, why to buy the foreign equities at increased fees if they perform more or less the same in both good and bad times. Again it comes down to fees. If you can buy foreign equities cheap, that’s not a bad idea in my opinion. This way you’ll minimise your risk and exposure to the US economy. But if your investment manager starts selling you a better index which doesn’t include only S&P 500 but also some more complex assets and more stuff for a “slightly” higher fee of 3%, just say no!

How Can I Invest in an Index Fund then?

Invest with Vanguard

I assume I convinced you already that you should start your investing career by investing in a passive index fund. In that case, a good option is to use Vanguard (www.vanguard.com). Vanguard offers lots of index options. The fees they charge are minimal compared to the average fund out there. The fees include an annual account fee on the total amount of your investment and a funds management fee depending on how passive or active is the fund you invest in. Both fees depend on how much you invest but to give you an idea, the annual account fee is around 0.15% on the total amount or just a fixed fee of let’s say $20 (the fees also depend on the country you live). Regarding the funds fee, if you invest in a passive index fund like the most popular cheap Vanguard 500 Index Fund you’re looking at around 0.05% – 0.1%. The fee also depends on how much money you will invest.

For UK investors, you’ll find here a list of products that Vanguard UK offer. You get charged a platform fee (online service, maintenance, support, etc.) of 0.15% on the amount invested (and cash reserves that you have in your account) plus an ongoing charge fee (OCF) depending on the fund that you invest in. For example, if you have £10000 in your account, you pay a £15 per year for their online service. Then, if you invested in the S&P 500 UCITS ETF, you’ll pay an additional 0.07%, that is an extra £7 a year. That’s all. Well, as you understand, the above example is over simplistic because the portfolio value changes every day, ie. it’s not £10000 every day for the whole year. The Vanguard fees accrue daily and the fees are paid on a quarterly basis.

You have three options on the vanguard.co.uk website: 1) ISA account, 2) Junior ISA, and 3) General Investing Account. You should always start with an ISA account in which you can invest up to £20K and your profits are tax deductible. If you have a kid or you are under 18 years old you can use the Junior ISA option. If you have taken advantage of the first two options and you have more than £20K to invest, you can open a General Investing Account.

Great Tip: Vanguard doesn’t charge you any transaction fees when you buy more and more shares in their index funds. How do they do that? They aggregate all the orders by all the investors and execute them at the end of the trading day. If you choose that way to invest, you don’t pay any transaction fees which is amazing! You are always given a second option (“Quote and Deal”) for buying ETF products at the current market price if you don’t want to wait. For that, they charge you a £7 fee. There is no reason to do that if you’re a buy and hold investor, so always go for the left option as below.

Another popular institution to invest your money including pension schemes is Fidelity (https://www.fidelity.com/). As of February 2018 Vanguard are also working towards a pension scheme option. Fidelity offers probably more options in terms of asset classes but remember, all fancy options usually come with a higher fee. I’ll say that again. You shouldn’t go down that route especially if you’re a beginner investor and since you’re reading this guide I assume you are one. As you learn more about the market and you go deeper, you can start investing a small amount of your money in foreign indexes or growth funds.

When is the right time to invest?

A good idea is to invest more and more money every month instead of investing a lump sum using dollar-cost averaging. Dollar-cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. Also, it makes sense to buy more shares when prices are low and fewer shares when prices are high. A lot of investors argue you shouldn’t enter the market when the stocks are overpriced but rather wait until the market has cooled off a little. As I’m writing this (March 2018) the market is really overpriced. If you have a long-term horizon trying to “time the market” doesn’t make sense. The problem with waiting for the right moment has potential risks too. That moment may take more time than you think, it may not come and in the meantime you may be losing money by deferring your investments. Rather you should start any time to invest a part of your monthly income into stocks and always smooth your returns by investing in the safer bonds.

Think about this. Let’s say you’re investing long-term and you’re worried about when to invest in stocks. Suppose that you invest in a bear market when the stocks are cheap. Great thing! But what happens after let’s say 8 years (just saying:) when the market has gone up and starts to go down again. Do you decide to sell and exit your positions until the next bear market? When’s that? I clearly see that this game is never-ending and trying to find the optimal point is both useless and impossible. This is a typical scenario when one thinks he is a value investor but in reality, he is a speculator. So, I’d recommend to start investing a small amount every month and when the stocks have become cheaper, you should be buying more.

Another thing I wanted to stress here is the time you spend on managing your portfolio. Time is money. So, I’m asking you a question. Compare an active investor who achieves an 8% annual return on his investment and a passive buy-and-hold investor who doesn’t spend any money and gets 6%. Who is better? Well, the buy-and-hold investor can forget his portfolio and spend his time on something that will generate more profits than the extra 2% that he would get by actively managing his portfolio. He could work more and invest his salary in his existing 6% return passive portfolio, right? If you are a Warren Buffett type of investor whose passion is investing and you enjoy spending hours doing research in the stock market, then that’s another thing!

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Stock Picking

If this guide were only 2-page long, I would encourage investors to put most of their money into a cheap S&P 500 index fund and diversifying by putting the rest into a world index fund that tracks international equities (again with the lowest fees possible). That would be still an excellent piece of advice that would generate high returns for your portfolio in the long term.

Does investing in stocks stop here? Not, of course. There are those who want to go further and pick individual stocks because you want to learn and find this process interesting. This chapter is for all of you then that have invested most of your money in an index fund and you’re now ready to dive into company reports, go deeper into how the financial markets work and hopefully pick those winners that will generate even more superior returns.

Warning: It’s not advisable to invest all your money picking stocks. Buffett says that he makes mistakes all the time picking stocks. Imagine how risky it is for an amateur investor.

What Companies should I Invest In?

First of all, I’d like to give you some tips on which companies to avoid buying. I’m not saying these are not good companies. It’s just their business model that is not ideal for someone who wants to invest in them.

You should avoid companies that use a competitive pricing model, ie. they always try to get more market share by reducing their prices and manufacturing costs. How do you expect to become rich by investing in companies that constantly squeeze their profit margins in order to survive in a highly competitive market? Less profit margins means less dividends for the investors.

These companies usually don’t make a unique product for which they can charge a premium. On the contrary, they make products which are easily substitutable in the market in the case their price is raised.

To give you some examples, when you want to fill your car’s tank with petrol, you’re just looking at the gas station with the cheapest price per litre. When looking for plane tickets, most people don’t care about the airline’s prestige – you just want the cheapest tickets.

Investing in price competitive businesses is quite risky. A new player appears who found a new technology which reduces the production costs and that’s it; all of sudden the new player snaps the whole market in a matter of months. These companies are fantastic examples of technological progress and innovation and do only good to the humanity. However, it’s not the type of companies that suit an investor like us who doesn’t want surprises over the next twenty or thirty years.

You should invest in companies that are nearly monopolies in their field and create innovative products. Apple designs great phones for which customers are willing to pay a premium. The company uses a customer value-based pricing model to price its products. This means that an increased customer perceived value allows the company to safely increase its prices. It’s interesting to mention here that Apple got it wrong when they priced the first iPhone at $599. They soon realised that they overestimated the customer perceived value and decided to drop the price to $399. However, as the iPhone’s popularity and perceived value increased, Apple increased the product’s price to around $1150 (Apple X) in less than ten years.

Coca Cola is a massive US company with an all increasing market share worldwide. Its sugary products are highly addictive and are sold frequently. What’s the possibility in the next 10 – 15 years that you’ll see a new Coca Cola? No matter the sugar taxes that governments are introducing in order to improve people’s health and reduce health care budgets, Coca Cola fans will always be willing to pay some a few extra cents to enjoy a can of Coke. Buffett once said that: “The single most important decision in evaluating a business is its pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business.” Long-term steady profits for Coca Cola means long-term steady dividends and capital gains for Coca Cola shareholders.

Take a look now at the semiconductor industry with companies like Intel, Samsung, Taiwan Semiconductor. This sector is highly competitive with all the participants fighting to make the next fastest chip. The one who wins will very quickly gain most of the market share in a blink of an eye. What’s more, all these guys consistently reinvest most of their earnings in research and development (retained earnings) to stay in the business game. Hence, they can’t pay out fat dividends to their investors. This type of companies is ideal for speculators who are waiting to get access to the latest information and news to buy or sell and make quick profits. However, as said before, this guide does not intend to teach you speculation. Here, we believe in long-term Warren Buffett style investing with all our heart.

Ratios, ratios, ratios…

A typical investor is not able to visit the company offices, speak to the CEO, spend hours in factories and offices to determine whether to invest in a company. What an investor can do is read the company’s reports and research any qualitative and quantitative market data about the company.

In this chapter, we’re looking at financial ratios that show a company’s performance in numbers. Financial ratios are relationships determined from a company’s financial information and used for comparison purposes. You can look at the ratios of one company against ratios of similar companies to decide which company’s stock to buy.

Warning: You shouldn’t base your investment decisions on a couple of financial ratios. Different companies are run by different managers, have different growth prospects, follow different accounting practices even if they operate in the same business sector. I’ll give you examples below.

Price to Earnings Ratio

A quick ratio that most investors use to determine whether to buy a stock or not is the Price to Earnings Ratio or p/e for short.

Let’s say that a company reported $2 million earnings last year and it has issued 1 million shares (shares outstanding). The earnings of course go to the owners, ie. the shareholders. So, your earnings as an shareholder/owner are $2 million / 1 million = $2 per share. If the share price on the market is $40, the price to earnings ratio is $40 / $2 = 20. This ratio shows how much new investors are willing to pay for every dollar that a company makes in profit. In the above example, investors pay $20 for $1 of company earnings. Hence, if we assume that this company will continue earning $2 million over the next 20 years and ignore the share price, an investor can get his money back in 20 years.

You’ll now think… Oh that’s my favourite ratio! I’m gonna buy the company with the lowest p/e ratio. The company’s earnings will probably stay the same in the short term and I’m gonna get my money back as quickly as possible no matter what happens to the share price! Well, it doesn’t work like that unfortunately…

Remember that the ratio takes into account the current market price of the stock. Most of the time, when people are not pessimistic, the market price reflects the real value of the business. So, if investors assign a low price to the share of the company, it means that they see no growth in the future and expect the earnings to go down.

Take for example Amazon whose share price has been enjoying a rally lately. The moment I’m writing this, Amazon’s p/e ratio is 248.24! That’s really high, don’t you think? For every dollar that Amazon makes, investors are willing to pay $248.24! This means investors must see future in this company to value it so high.

Amazon currently has different business segments but take a look at Walmart, an Amazon’s competitor in the general merchandise segment. Walmart’s p/e ratio is now 23.48. Most would agree that there’s lots of buzz around Amazon lately and its price looks overpriced but you shouldn’t rush to buy Walmart because it’s traded at a much lower p/e ratio. A high p/e ratios is an indication that Amazon is expected to grow much more than Walmart in the future. There may be some truth there, there may be not.

Another thing (and common mistake between new investors) is that you should always compare p/e ratios of companies in the same industry. Different industries have different p/e ratios which are considered good or bad. In the above example, I didn’t compare Amazon with Coca Cola. To be honest, Amazon may not have been the best example as it is a unique company in the sense that it’s growing rapidly towards different directions like technology, e-commerce, media, etc. That’s why Warren Buffett decided to pass on Amazon. Which company can one compare Amazon with? That’s a tough one!

Generally speaking, technology companies trade at higher p/e ratios than more traditional companies like textile, manufacturing, etc. because investors expect more future growth. During a bear market like that of 2008 however, technology stocks plummeted so much much that traded at p/e ratios lower than other types of business such as consumer staples (food, beverages, household items, etc.).

Price to Book Ratio

Another useful ratio is the Price to Book Ratio which compares the price of the stock to the book value of the company. You can calculate this ratio by dividing the current share price by the book value per share.

P/B Ratio = Current Share Price / Book Value per Share

The numerator reflects the market value of equity whereas the denominator the book value of equity. In most cases, the market value of a business will be higher than the book value. The book value of equity shows the net worth of the company (assets – debt) if the owners would decide to close the company down and sell it tomorrow. But of course a company is usually worth more than its book value as it’s an entity that creates profits and new assets. A company has also intangible assets which can’t be measured by simple accounting. Take the example of a company paying a higher premium to acquire another company. The premium reflects the goodwill, ie. intangible assets coming from a strong brand name, loyal customers, patents, proprietary technology, etc.

The P/B ratio can be helpful for evaluating for companies with negative earnings because in that case, the p/e ratio becomes useless. Think about this. In theory no one would want to pay something for a liability, ie. a company that incurs losses. However, investors are still buying the company which means there must be something else that’s good in this company.

In some other cases, when a business doesn’t have lots of tangible assets on its balance sheet the P/B is of little use. Think about a technology company operating online that doesn’t have any assets, offices, equipment, etc. but still is growing and making profits.

Return on Invested Capital

A company needs money (capital) to grow. How does a company get this capital? It can either borrow money (debt, short-term or long-term) or invite others to share ownership in the company by going public (equity).

A company borrows money (takes on debt) because it’s planning to use that money to grow. In the end, the company pays back its lenders and also makes additional profits for its owners that would have been impossible to make, had it not borrowed the money.

Talking about equity, the company decides to share ownership with people like you and me who buy its stock. This way, the company is willing to share future profits with other investors in the future. Why? Because the company has a specific plan to grow with the money that is going to receive from investors like you and me. The extra profits would have been impossible without the shared ownership, ie. the money raised through selling stock to other owners. The owners of a company which goes public aim to make more money through sharing the profits with others like you and me. They aim at a win-win for themselves and other investors.

A good company is one which uses the raised capital (debt or equity) in an optimal way to make profits. A few companies fail to make good use of the raised capital and go bankrupt. Obviously, you want to stay away from them. Now, think about this. You have a Company A that takes capital x and produces 1.2x after a certain time and you also have a similar company B that takes the same capital x and produces 1.3x after the same time. Which company would you be willing to invest your money? Company B. Because company B took the same capital and made more money. So, it looks like the engine of Company B (assets, people, management, etc.) worked harder and produced more than the Company’s A engine. Pay attention, I said similar company. Different industry sectors have different profit margins.

The ROIC ratio can be calculated like this: ROIC = (After-tax income) / (Equity + Debt)

You don’t have to calculate this yourself by looking at the company’s financial statements. You can find these ratios on websites like valueline.com or morningstar.com. Consistent ROIC greater than 15% shows that the company’s engine works quite well. Does this mean that you should rush to buy a stock which meets this criterion? Not, of course. It’s one thing to take into account. Valuation is another according to Warren Buffett. You don’t only have to spot a great company but wait until the right moment to buy it when it is underpriced. There is no point in paying too much even for a great company.

Return on Equity

Another ratio to look at is the Return on Equity ratio (ROE) which shows how efficiently a company reinvests its retained earnings, ie. the earnings that doesn’t pay out as dividends to its shareholders.

Before defining ROE we need to understand a few things first. Let’s say you want to sell your car. To decide what’s a fair price to ask for, what do you do? You check online or in a newspaper to see how much others are asking for the exact same car.

If you wanted to sell a company that is listed on NYSE, what would you do to work out a fair price for the whole company? We’ve said that stocks represent ownership, ie. each person holding shares is a part-owner. So, an idea is to take the total number of shares and multiply them by the current market price on NYSE. That’s the market value of the company according to the stock market. That number shows how much you would have to pay all the part-owners of this company out there to get the 100% ownership from them and become the sole owner. It’s how much the owners themselves value their company. To go back to the car example, “if you want to have my car, this is how much you have to pay me!”

Now, the owners could ask a crazy amount of money for the ownership of their company, car, or whatever. You wouldn’t agree with any price, would you? As a smart buyer, you have to analyse the company’s financial statements and come up with an objective value of this company. So, let’s see, what’s this company really worth? What are its assets? How much money does it owe to its lenders (liabilities)? So, if I sold everything that belongs to this company today and paid back for all its liabilities, how much would I be left in my pocket? That’s the book value of the company which is a more objective value. So, the book value is the value of a company according to its “books”, ie. financial statements. It’s calculated by taking all the company’s assets and subtracting its liabilities. It’s also called shareholders’ equity.

So, how on earth these bloody owners are asking $20 bn for this company whose book value is only $1 bn? Well, that’s a premium which reflects the future expectations that the owners have from their company. This means that the owners truly value their company and expect its book value to increase because the company is doing exceptional work, producing new products, expanding abroad to new markets, and so on. In other words, the company will generate more assets in the future which will bring its book value up.

And something else. Forget the future profits. As we said earlier a company doesn’t have only buildings, equipment, products. It’s the strong brand name, the loyal customer base, patents, proprietary software and processes. That’s the goodwill for which somebody would have to pay to get full ownership of a company.

In other cases, the owners lose faith in the company and they’re ready to dump their ownership (shares) for a low price. In that case, the market value is less than the book value (market price – discount to the book value). This means that the owners believe that in the future the company’s assets will decrease, sales will go down, debt will bring the company to its knees, etc.

The Return on Equity is calculated as follows:

ROE = (Net Income) / (Book Value).

The ROE is an additional ratio that an investor should look at to determine how efficiently a company is using retained earnings (the profits that reinvests into the business). A consistent ROE ratio of more than 20% is a sign of a healthy company. The point here is that if the business is not generating more assets by reinvesting the profits, it should better be returning the profits back to its owners in the form of dividends. So, would an investor invest in a company that neither pays dividends nor makes efficient use of the money invested by shareholders?

To summarise, debt or equity is capital, ie. money that lenders or owners have given to a company in hope of future growth and returns. Warren Buffett in a 1992 Berkshire Hathaway Shareholder Letter said: “Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.” Notice, he mentions incremental capital which is very important. That’s a variation of the typical ROE ratio, which shows how much extra return can a company produce by giving it some more extra capital? Imagine a company as a motor engine. How much power does it give back when you give it a small amount of extra fuel?

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How much should I pay for a stock?

As with any type of investment, when you invest in a company’s stock you expect some returns back. “Why shall I invest in you guys and not in something safer like US government bonds (Treasury Bills)?” The chance that the US government or some government defaults is generally less than the chance a corporation defaults.

Let’s have a look at the “what’s in it for me” when it comes to investing in stocks. Every year a public company announces its earnings. The earnings obviously go to the owners in the form of dividends. Dividends can be paid out either in a form of a cheque (cash) or the investors can choose to reinvest them by buying more shares of the company.

A company usually provides additional incentives to those who want to reinvest their dividends. For example, the company offers additional shares at a discount price. In any case, especially small investors who want to avoid paying commision fees to brokers for buying more shares choose to increase their holdings instead of a dividend cheque.

So, just like a coupon bond gives back coupon payments to its holders, a stock gives back dividends to its owners. But a company doesn’t give all its annual earnings back to its shareholders. Part of the earnings is reinvested so the business grows and generates more profits in the future. The earnings that are reinvested are called retained earnings. The investors are happy with the business keeping some earnings to create more growth in the future. That’s the whole point of investing. This is what you would do if you owned a family business yourself. So, as an investor, you want to see growth coming from reinvesting the earnings. A ratio that investors use to determine whether a business is better off reinvesting its earnings is Return on Retained Earnings (RORE).

When you buy a company’s stock and keep it for, let’s say, 10 years, you enjoy annual dividends and in the end (maturity of the investment) you can sell the stock to some other investor hopefully at an increased price which reflects the company’s growth over the last ten years and its future prospects. So, by looking at stocks this way, we realise that they are similar to bonds which offer regular coupon payments and a final payment (face value) of the initial amount invested by the bondholder investor.

To determine whether a stock is overpriced or underpriced you can look at its dividend yield. Yield in general is the income return on an investment (usually expressed as annual yield, ie. how much interest/income you get every year). The dividend yield is the ratio of the dividends divided by the share price. Dividend yields is a tool for conservative investors who prefer to receive regular income from a company rather than putting all their hopes in future growth prospects.

You should be looking at companies with a history of steady dividend yields. If you want to check dividend yields for Coca Cola for example, you can go to a website like www.morningstar.com or www.valueline.com and see the dividend yields for the last ten years or more. This is a screenshot showing that Coca Cola offers a steady dividend yield of around 3%. Remember, that’s only one part of the investment return for Coca Cola shareholders. The share price over the last ten years (2008 – 2018) has almost doubled.

Trailing dividend yield above means that future dividend yields are calculated based on the dividend payouts of the previous 12 months. There is another term called forward dividend yield which calculates the annual yield based on the latest dividend payout. For example, if in Q1 a company paid out $1, it is assumed that for the next three quarters it will pay $3. Thus, if the share price is $100, the forward dividend yield is calculated as $4/$100 = 4%.

Warren Buffett’ on Picking the Right Businesses

Buffett always encourages investors to invest in companies they understand. OK, you want to invest in this company. What does the company do? How does it make money? What makes you think it will keep making money in the future? You’d better have a good answer to all the previous questions. Don’t invest because your neighbour or everyone else is investing.

Buffett never fully understood the business model of tech companies that’s why he never took the bet to invest in them. If you are an expert in your sector and you understand a company, then go ahead. Maybe you are a surgeon and you see that a new company which specialises in medical appliances will change how the surgery will be done in the future. Then sure, go ahead and invest in that company. Peter Lynch, the mutual-fund star of the 80’s used to says: “If you’re in the steel industry and it ever turns around, you’ll see it before I do. Use your specialized knowledge to home in on stocks you can analyze, study them and then decide if they’re worth owning.“

Amazon has been enjoying an incredible success over the last few years. And when I’m saying success, I don’t mean stock price but tremendous company growth. Buffett has said about Amazon: “It’s a tremendous accomplishment what Jeff Bezos has done. He’s a wonderful businessman and is a good guy too but, could I have anticipated he would reach that success? I’m not good enough to do that. But fortunately, I don’t have to form an opinion on Amazon.”

Buffett didn’t take a bet in the technology sector either. How could I, he says when I see new technologies overpassing old ones so quickly. For example, there is no company that makes radio equipment or televisions in America at the moment. Google? Facebook? He couldn’t form an opinion on those either. He says: “If I’m not sure who’s going to be the winner I don’t buy”.

Buffett did form an opinion on Coca Cola though, a company that has been around since 1886. Coca Cola sells 1.9 billion drinks every single day in more than 200 countries. Tech changes constantly, some buy Google, others sell Google but everyone drinks Coke!

Buffett said: “Define your circle of competence and operate within that circle”. It’s enough to pick 4-5 winners in that circle to deliver extraordinary results in your investing career.

Buffett admitted at an annual meeting of Berkshire Hathaway that he missed his chance to buy Google or Amazon. He explained that he couldn’t understand their business model and wasn’t sure these companies would keep making money in the long term. It’s remarkable to hear such an investor admitting humbly that he missed two of the most fast-growing companies of the last 20 years. He’s still the most successful investor which proves his point that it’s not necessary to buy the next Amazon to have success in the stock market.

The funny thing is that Buffett appears indeed emotionless when making such statements and even reassures everyone that he’ll keep missing great investment opportunities in the future. That’s the virtue of a successful investor. He stays in his circle of competence and is perfectly OK with that. Being emotionless when everybody else around is high buying the “hot” stocks is the only thing you need to achieve success.

The other piece of advice from Buffett is to invest in companies with good management. A good management acts in the interests of the shareholders. Look for companies whose management doesn’t change very often. The management in Berkshire Hathaway has a very low turnover.

Check the letters to the shareholders against the company’s performance. Did the management deliver on their previous promises? If not, how did they explain the poor performance? Did they attribute the failures only to a bad economy or market circumstances? Did they ever accept their mistakes? How much does the management get paid? Check the CEO’s salary.

Another good indicator is when a company buys back its own shares (buyback or repurchase). A company usually buys back its shares when they think that the share is undervalued by the market. By buying back outstanding shares, the number of the available shares in the market goes down which makes the share price go up. That benefits current shareholders.

Good management doesn’t focus only on how the company’s share is performing but they are continually trying to generate growth and revenues from new operations. Buffett evaluates a company based on its return on retained earnings (RORE). A high RORE means that the company retained part of their earnings (they didn’t give it back as dividends for example), reinvested it and generated more earnings. This shows that a company has growth prospects and doesn’t use profits just to keep the current operations going. Remember, Buffett is looking to invest in companies for the long term, become part of the company and grow with the company. Giving back to the shareholders through dividends is definitely a good sign of acting in the interests of the shareholders but reinvesting and having a high RORE is an even better thing which shows growth prospects and more dividends in the future.

Choosing a Broker

And now that you’ve learned so much, it’s time to choose a broker and trade stocks online. Financial institutions like Vanguard and Fidelity that we mentioned earlier don’t offer the option to trade individual shares. There are lots of options online but you have to consider a few things when choosing the right broker. First and foremost, make sure you understand what is the cost your broker will charge you when you buy or sell shares. There are different costs like fixed online platform costs and transaction costs based on your trading activity, ie. the type of trades, the exchanges in which you trade, the trading frequency, the trading volume, etc.

A fantastic site that you can use as a beginner to find the broker that suits your needs is Broker Chooser. On their site, you are asked a few of questions and they direct you to the best options based on your answers.

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Open an Account with DeGiro

One of the best online broker platforms for someone entering the world of investing with a limited amount of investment capital is DeGiro.

DeGiro is based in the Netherlands and is regulated by the Dutch watchdog AFM. The only downside at the moment is that they are only operating in 18 countries in Europe as shown below. So, if you live in America and you are considered a person under IRS (Internal Revenue System – America’s national tax collection agency) you can’t open an account. You are asked to explicitly declare that when you apply for a DeGiro account. For all of you based in the US or anywhere in the world I have another broker suggestion below.

The reasons I’m recommending DeGiro over other online broker platforms are the following:

1. Their transaction fees are very low. Check out this fee comparison page on their website.
2. There are no fixed platform fees. The only fees you have to pay are the exchange connectivity fees. From DeGiro Website: “DEGIRO charges a fee to set up trading opportunities outside of your home market. This is to provide access to a large number of exchanges.” So, if you open an account on www.degiro.co.uk (co.uk ~ British version of DeGiro) you don’t pay any exchange connectivity fees for trading stocks on the London Stock Exchange. But if you make any transactions or you hold positions in a foreign stock exchange other LSE you pay an annual fee of €2.50.
3. No platform fees means you can open a DeGiro account and stay inactive for as long as you wish before you do your first trade without paying anything. For example, you may want to open an account, top up with cash, get familiar with their interface, do research in a few companies and buy when you find something at a good price.
4. There is no minimum capital requirement to start investing. You can deposit $50 and buy a share of Coke for example (43.26 as for today 20th of March 2018). That’s amazing, isn’t it?

DeGiro mission statement reads: DEGIRO seeks to make custom made financial planning and finance affordable for everyone around the globe.

They have done exactly that! Anyone can start investing with any amount. That’s a fantastic thing. No excuses guys. As I said earlier, don’t spend your money on silly things. Don’t be a slave to your money. Become an investor. With as little as $10 you can buy a share listed on Nasdaq, a company’s share which has probably been hit by some temporary bad news. Buy 10 – 15 shares and become an owner of a company with growth prospects instead of buying a new pair of jeans. It will pay off long term.

I opened an account with DeGiro a while ago on the UK website www.degiro.co.uk. You can literally open an account in ten minutes and start trading immediately. For the UK website, you need to provide a valid UK bank account and also have a National Insurance Number (NIN). As I said, you have to declare you’re not considered an IRS person.

After you finish your registration, you have to also complete an appropriateness test in which you acknowledge the risks of trading and you also have to transfer money to your account.

You have two options for that: 1) Using Sofort, a third party Instant Deposit Provider, 2) Manual transfer (You use online banking or mobile banking and you send manually a payment to DeGiro as if it was a payment to an individual).

Although with Sofort you can get the money transferred in minutes, I’d suggest you do the transfer manually through online banking as Sofort is a third party and may charge you additional fees. Investing doesn’t guarantee returns itself so there is no reason to pay higher fees for simple transactions like that. Avoid losses from the very beginning. If you had to transfer money quickly in order to buy, it would probably make sense to pay a small fee to Sofort but you’ve realised we’re not day traders here.

Buy Shares on DeGiro

After the transfer is completed, you will get access to the trading platform where you can buy stocks. You can search for particular shares using the search bar on the top. You can search by company name or ticker symbol. A ticker symbol (or stock symbol) is an abbreviation which uniquely identifies publicly traded shares on a particular stock exchange.

Let’s say you want to buy Tesco shares traded at the London Stock Exchange. Go to the top search bar and search for “Tesco”. Click on the first result (you can see the stock exchange underneath – LSE).

That will open up the relevant information and chart for Tesco. To buy shares you can then click buy on the right. Warning: Make sure you understand what you’re buying. The same company’s stock is traded on different stock exchanges around the world.

In the following pop up window, you can enter how many shares you want to buy and either place a market order or a limit order (Order Type).

A market order is a buy or sell order supposed to be executed immediately at the current market prices. So, if you place a buy market order for 100 Tesco shares you’re saying: “What’s the lowest price (ask price) at which I can buy 100 shares on the market now? I want them now!”

You can also place a buy limit order which means you set a price at which you want to buy the shares. So, if the Tesco ask price (the price at which someone is willing to sell) is currently £69 and you set a limit order at £66, you’ll have to wait until the market price falls and eventually someone wants to sell you at £66.

When placing a limit order you also have to specify the time frame within which the limit order should remain active – valid. You can choose between day order or GTC in the Order duration drop-down menu. Day order means your limit order is valid until the end of the current trading day. GTC is an acronym for Good Till Cancelled which means the order is active until it’s executed or cancelled by yourself. So, it can be executed in three days, two weeks, or never. Well, if you place a limit order to buy Tesco at £1 when it’s currently trading at £200, the chance that the price falls to that level is almost zero.

Final Important Words about DeGiro

You see it’s pretty easy to create an account on DeGiro and start trading. It’s just as easy to lose your money though! I understand that you may want to start with a small budget but don’t just buy one share here, one share there. Remember every transaction comes at a cost. DeGiro may be one of the cheapest brokers out there but they still charge fees in order to provide you with this platform and all this variety of products. Please have a look at a screenshot below with their fees (as of March 2018).

For example, if you buy a couple of UK stocks, that will cost you an extra £1.75 + 0.004% * stock price. Now you understand why all the examples on their fee comparison page assume you buy £1000 worth of shares and not £30! It makes no sense to buy fiver shares today, another five tomorrow, and another five next week. Do your research, buy a good number of shares of a good company at a competitive price and let them grow.

It makes no sense to look at the prices every day, every hour, every minute, every second! That’s a waste of your time! Remember what Buffett said. You should be comfortable to buy without having to check the price regularly. It makes no sense to keep your eyes on the screen getting excited. Of course, it’s interesting in the beginning when you’re new to the platform but you have to realise that you should make better use of your time instead of looking at the green and red flashes on DeGiro (when somebody buys or sell respectively) and the chart going up and down. Forget your position and spend your time on things that matter like reading books, annual reports, financial statements, news, etc. Be an active reader and keep learning everyday.

It’s amazing how much time people waste on looking at their positions every day. It’s like another Facebook, another Twitter or even worse! I think it was Paul Graham, the founder of YCombinator who said, the global productivity fell sharply in 2017 because of everyone is constantly checking the cryptocurrencies prices!

Important Warning: For those of you who want to buy an index like S&P 500 on DeGiro (NYSEARCA:SPY)(NYSEARCA:VOO), recent EU regulation MiFiD starting from January 2018 require that US institutions provided detailed information (KID – Key Information Document). Until those documents are provided you can’t buy US ETF like the famous Vanguard ETF VOO. From DeGiro: “In accordance with new European legislation (MiFID II), parties issuing ETFs and derivatives are obliged to provide documentation in the language of country where the buyer resides. This in order to better protect and inform buyers. Many foreign issues still choose to write these documents in their own local language. These products will no longer be purchasable on our platform, starting from the 2nd of January, lasting until the language requirements are met.”

Open an Account with Interactive Brokers

If you want to invest in individual stocks rather than in an index fund you can open an account with Interactive Brokers. The reason I’m recommending them is their competitive brokerage fees. Remember that the commission fees can have a huge toll on your earnings. There is no reason to pay $10 commission fees for buying 100 Apple shares if you can buy them somewhere else paying only $2. Yes, you’ll get the exact same 100 Apple shares at a better price!

The fees that brokerage firms out there charge are outrageous! I was doing a market research on UK brokers the other day and found that buying £1000 of Tesco shares (British multinational grocery retailer) can cost you from £2 up to £50! Ouch! Slow down, you golden brokers! You’re not hunting these stocks in the forest, are you?

The brokers “justify” their high fees by providing additional services like research tools, fancy P&L interfaces, personal advisors, etc. You don’t need all that. What you need is to do your own research, follow a few people who know what they’re talking about, learn a ton of things, start reading annual reports, etc. Yes, you have to do all this if you want to invest your money in individual stocks. Stock picking means you have the time and passion to do your due diligence. If you don’t fancy all this stuff, simply invest in an index fund and spend your valuable time on something else that you enjoy.

I commit myself to be updating this guide regularly to help you and other aspiring investors on how to start investing in stocks step by step by pointing them to the right brokers. I have spent days chatting with the support of brokerage firms trying to dig out all their fees and some extra fees and some hidden fees in small fonts, etc. So, I’ll do my best to keep you up to date.

However, I encourage you to do your own research and compare brokerage fees as these change from day to day. I have devoted a whole chapter here to Interactive Brokers (I don’t affiliate with them) as they are global (you can open an account no matter where you’re based) and their brokerage commission fees are indeed very low especially if you’re planning to trade US stocks. They also offer international shares, bonds, ETFs and other securities but compared to other brokers their US share transaction costs are quite low.

As I write this (March 2018), you don’t have to pay any fixed fees for the first three months after a successful application. By the way, you have to go through an application in which they ask all sort of questions for security purposes and money laundering protection. After the first three months and your trading activity results in more than $10 of commission fees, you don’t pay any more platform – maintenance fees. If the transaction costs of your trading activity are less than $10, you get charged the difference, ie. $10 – total transaction fees. So, if you didn’t trade too much and you had only $4 transaction fees, at the beginning of the following month you will have to pay an extra $10 – $4 = $6. If you haven’t traded at all for a month, you’ll have to pay $10 at the beginning of the following month.

To start trading you have to deposit a minimum amount of $10000. If you are a student or less than 25 the minimum requirement is $3000. Also, in that case, your minimum activity fees are $3 per month instead of $10. To see all the minimum requirements check this page.

If you transfer your money from a bank account, that’s usually done through wire transfer. There is a deposit hold of usually 3 business days. After that, you can always transfer money back to your bank account if you need. The first withdrawal in each month is free but any subsequent withdrawals come with a withdrawal fee. The withdrawal fee is $10/ withdrawal if your account is in dollars.

The withdrawal fee for British pounds will be £7/ withdrawal (per wire as IB love to say:). The money will be held in your account in the same currency as your deposit. In other words, if you transfer USD, it will be held in USD in your account. If you transfer GBP, it will stay in GBP. Bear in mind that IB doesn’t charge extra commissions for incoming deposits but your bank may charge you for either withdrawals or deposits. So, please check with your bank.

Regarding dividends that stocks pay out, these get deposited directly into your IB account. Their interface also gives you the option to reinvest your dividends, so in that case, you buy new shares in the open market. The new shares will be purchased on the morning of the trading day which follows the confirmation of receiving the dividends in their system. As shares are purchased in the open market, generally at or near the opening of trading and subject to market conditions, the price cannot be determined until the total number of shares for all program participants have been purchased using combined funds. In the event that the purchase is executed in multiple smaller trades at varying prices, participants will receive the weighted-average price of such shares. Each investor in the platform will receive new shares at the same price otherwise they would make us angry of course.

If you own US shares you have to also pay dividend tax to the US government. That’s the withholding tax rate which is usually somewhere around 15% – 30%. The rate depends on the investor’s country of residence (legal country). So, if you are entitled to dividends from US stock, IB withhold a 15% of your dividends earnings which go back to the US government. This is the relevant article which shows in the first column the country you buy stocks in and in the second column your country. If your country is not in the second column, that means that your default withholding tax rate will be 30%. Yea, I know that’s sort of off-putting.

Regarding capital gains, the US government doesn’t charge any capital gains. You have to report these only on your tax return in your country of residence.

At the very first step of their application, you’re asked to provide the legal country (country of residence). Once that is set you can’t change it. So, if you made a mistake, you have to restart a new application. If you change country of residence, you have to let them know.

If you have more questions about them, I would suggest that you start an application. Once you start an application a chat service becomes available which you can use to ask them any questions. I hope this chapter asked most of your questions but feel free to ask as many questions that may arise. Also, feel free to drop me an email with any questions you have.

More Quick Investing Tips

It’s time-consuming to go through annual reports and find good stocks. If you have done your due diligence and have found already a promising stock, check online and find financial managers that own the same stock. Research further their portfolios to look for other stocks with the same good qualities of your stock. That will help you with your investment strategy and will develop your sense of picking the stocks with the same good characteristics. Of course, you should be always doing your due diligence on your new stock candidates but this way you have more chances of finding good stocks as opposed to picking candidates at random out there. It’s like taking advantage of the research and digging that someone else has already done. I’m not saying that you can blindly invest without doing your research though. It’s all about finding possible candidates.

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“There are many roads to Jerusalem”, Max Heine (founder of Mutual Series Funds) used to say. He meant there are different ways you can pick good stocks. Different financial managers have a different approach but in the end, they all end up investing in the same good companies. Some are looking for low multiples of earnings (low p/e ratios), others are looking at the assets, steady cash flows, solid long-term growth, able management, etc.

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A great tip is to first hone your skills at picking stocks using an online demo account instead of investing with real money. You can set up demo accounts on sites like www.morningstar.com, http://finance.yahoo.com, http://money.cnn.com/services/portfolio. Obviously, investing with fake money doesn’t give you the same emotions as investing with your real money. However, it will give you a few lessons and you’ll get an idea of how much you enjoy stock picking.

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Are the company’s statements well understandable? If you see words like nonrecurring, extraordinary, unusual, costs, that’s alarming. Nonrecurring costs for acquisitions. When a company keeps acquiring other companies because it can’t make money on its own, then those are not recurring costs but recurring ones and reflects how the business is making money, by acquiring other companies.

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Businesses tend to motivate their high executives with stock options and other incentives based on the share price. The result is that the managers shift their whole focus on driving the share price up instead of making the business better. They will do whatever it takes. They will even allow even obscure accounting practices towards this goal. The share price will hit the sky, they will exercise their options and will cash in (usually by having the right to sell their shares back to the company). And a time will come when the roof will fall in. All the management efforts were wasted on making the company look good rather than be good. And the company will fire the manager. But the manager is not sad for being fired! No, no, no! As Warren Buffett said in one of his letters: “Getting fired can produce a very bountiful day for a CEO. Indeed he can earn more in that single day, while cleaning out his desk, than an American worker earns in a lifetime of cleaning toilets.” So, always look for companies that issue stock options up to 3% of shares outstanding and generally provide other incentives for outstanding performance to their management.

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You can also listen to company’s conference calls you own even a small number of shares. Contact the investor relations department or check the company’s website to find out how you can attend these conference calls. You should always watch or attend annual meetings where CEO’s and CFO’s present and analyse business performance. This is for example an annual meeting of the Schindler Group in the investor relations section of their website. This is Microsoft’s investor relations dedicated page with regular podcasts with the company’s executives.

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When a new CEO gets appointed check in the company’s annual report if there is any management turnover. If there is, it means that the new CEO is trying to get rid of bad people in the company. If that keeps forever though is obviously not healthy for a company.

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This is a great book that you may consider reading if you want to do some proper research digging into a company’s financial statements. If you are a beginner you shouldn’t be investing most of your money in individual stocks. You should invest in index funds as Buffett advises and maybe allocate a 10% or something for investing in companies that you have thoroughly researched and believed in. When investing in individual companies you should be always digging into their financial statements.

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Benjamin Graham, Buffett’s teacher said that “the market is a pendulum which swings from unsustainable optimism and unjustifiable pessimism. The intelligent investor is a realist who sells to optimists and buys from pessimists”. To give you an idea of this swing. During the 1990’s the stock market enjoyed a phenomenal rally because people were getting unsustainably crazy about technology stocks. This rally ended really bad with stocks going down 50.2% between 2000 and 2002 and the market suffering the worst hit since the Great Depression. Before the crash, more and more investors were willing to buy at higher prices (unsustainable optimism) whereas, after the crash, more and more investors were willing to sell at lower prices (unjustifiable pessimism).

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The most important lesson is avoid losses. If you lose 95% of your investment, you need to gain 1900% to get back to your money. The math shows is easy. If you invest x and lose 0.95x, you end up with 0.05x. To get back to x, you need a 1900% return on 0.05x, ie. 0.05x + 1900/100*(0.05x) = x.

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You have to understand that the market doesn’t always show the right price. Most of the times, yes, the stock price represents the true value of a company based on its growth, earnings, and the value it gives back to its shareholders. However, there are times when everyone gets over excited and is willing to pay more than an objective value to get their hands on the stock. And on the other hand, there are times when everyone wants to dump the stock for much less than it’s really worth.

Think about this carefully. Just because someone is calling you to walk this path of total absurdness by either getting over excited or over depressed doesn’t mean you have to follow them, right?

If you did your own research and decided to invest in a good company that cares about their customers and makes great products which are getting an increased share of a market and the company has a great management which don’t talk BS on TV every day, and, and, and… then good! You’ve taken a good investment decision. Buy that company and sit on their stock for a long time.

Now, if further down the road, a new fancy thing appears on your way called let’s say bitcoin and everybody is calling everybody else to join the new bitcoin era, don’t follow the lunatic crowd! YOU have control over your own decisions. No one can dictate how you should feel and react. You are a human being with brain, experience, knowledge and values. You are 100% capable of being in charge of your own decisions and sticking to them. You can think and decide for yourself. Don’t get into this hype of changing constantly directions in your investing life just because everybody else does so. Success in your investing life and personal life will come from choosing one direction dictated by your values and beliefs and walking towards that direction every day with patience.

To make another association in real life, if you are a great music talent and you’re born to become a pianist why would change plans and become a lawyer just because everybody else around you wants to become a lawyer? Only you know what’s right for yourself.

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A great tip is to buy a good company after its stock has suffered a hit because of some bad news, a temporary loss, an unfortunate event. In July 2002 Johnson & Johnson stock price went down 16% in a single day because regulators were investigating false record keeping in one of its factories. Such events and bad news can hit a big company in the short term but they have no impact in the long term. You should spot opportunities like this and buy big companies when they trade at a competitive price.

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Successful investors spend great effort on what they do and how they do it and don’t pay attention to what the market is doing. Also, they are very disciplined and refuse to change their approach if it’s unfashionable. Technology stocks in the 1990’s became an investing fashion trend. Technology stocks were the only ones that you should have in your portfolio.

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More Warren Buffett Wisdom

Warren Buffett said: “To become a successful investor you need to have a sound intellectual framework for making decisions and keep emotions from corroding that framework”.

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Cash is always a bad investment. You need to have enough cash to meet your needs, if you stay out of work, in case your car is broken, dentist, etc. But you don’t have to hold an excessive amount of cash. If you have a surplus amount of cash, that’s not good. Cash doesn’t produce anything. I’d rather invest in a good business than having cash. The dollar is going to be worthless over the years. There will be no tendency towards deflation over time in this country, on the contrary, a tendency towards inflation.

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Invest in things that produce something for do. Take gold for example. “I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion…you could have all the farmland in the United States, you could have about seven Exxon Mobils (NYSE:XOM) and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67-foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.”

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If you risk something important to you, for something not important, that’s foolish. Make smart bets. If you give me a gun with a thousand chambers, or a million chambers, there is a bullet in one chamber and someone says pull it how much do you want to pull it once? I’m not gonna pull it. You can name any sum you want, but it doesn’t do anything for me. I’m not interested in that type of a game and there are people doing it financially.

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Define the circle of competence. I like computers, I like the Internet but I don’t know who’s gonna win. The same happened with radio, television, etc. There is no TV or radio manufacturer in America at the moment. Coca cola is here since 1886. People chew chewing gums still. Don’t listen to others around you getting excited about Bitcoin, stocks market going up etc. You control your emotions and you know your circle of competence.

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Look for simple, easy to understand companies, with a good honest management, companies that you should have a fair picture of where they will be in 10 years. Buy those companies. People buy a company and they check the price of the stock next day to see if they did the right thing. When you buy a company you want to grow with that company, you’re part of the company, you believe in the company, you’re not a speculator. This is what Benjamin Graham taught Warren Buffett.

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You will make enough money, it’s not necessary to have huge amounts of money in order to enjoy yourself, I live in the same house for years, if you have a reasonable job you’ll be eating in McDonald’s and you’ll be eating in McDonald’s, we’ll be eating the same food, we’ll be watching the same films, we wear the same clothes, maybe I pay more for my suit but once I put it one we almost look the same, if your house has 50 more rooms doesn’t make any real difference, it will probably bring you problems, I’ve been to houses that were 200 times bigger my house and I wouldn’t be any happier in those houses. 24 hours in the day and this is where the hours go. Great wealth is the tiniest bit different. To trade a decent income doing something you love and you feel worthwhile for huge wealth or something that you trade off lots of your principles, that would be a huge mistake.

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The problem with commodities is that it’s an investment that you put money today and you just wait to see what somebody else is willing to pay for that 6 months later. The commodity itself can’t do anything for you. The asset can’t produce anything. If you buy a piece of art, the piece of art doesn’t produce anything. I prefer to buy a piece of land which can produce something for me over time.

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Vague accounting principles are alarming. We want the CEO to be able to explain in simple words what’s happening.

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Beware of CEO’s that love to predict things about their companies. If a CEO announces publicly that his company’s Earnings per Share will grow 15% for the next 20 years that can have bad consequences. It starts with unjustifiable optimism. Then the CEO tries to hit this target and cook the numbers both with operational tricks and accounting tricks. So, they don’t focus on the business but on how to make the numbers work to meet their predictions.

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Beware of companies boasting great EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Depreciation is an unattractive expense because the cash is paid up front for an asset that hasn’t done anything for the business yet. Imagine you pay the employees of a company their salaries for 10 years up front. It’s the same thing with buying assets that haven’t delivered anything yet.

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Managers that tend to predict growth numbers also tend to make the numbers up later.

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Most of the times board directors are passive. It’s tough to raise a question of replacing the CEO. It’s tough to object to an acquisition when the CEO himself has proposed this acquisition and everybody else is approving unanimously this decision. Again psychology here, people act like sheep. No one wants to appear bad or different or critical. No one wants to be picky on the CEO’s pay package and stock options.

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The job of board directors of a mutual fund is to appoint the best investment manager and negotiate his fee. The directors often fail to achieve this. They appoint a manager based on what other funds do. When the things go wrong they are ready to sell the fund to someone else who has performed well, which proves that their first option was totally wrong even though that manager was available back then and at a better price than the one they chose first. The directors often fail to negotiate fees because they have no incentive themselves. If they were offered a small portion of the savings from cutting down the fees, they would do a much better job.

**

Textile operations were not worth continuing. Buffett mistakenly didn’t see that sooner. The reason was production in foreign countries with much more minimum wage. The management did a great job to make the business profitable and were not to blame. When the economics of a business are crumbling, talented management can slow the rate of decline but fundamentals will overwhelm managerial brilliance. If you want to be a good businessman, make sure you get yourself into a good business.

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Charity donations will have to have a benefit for the company and also donations effect has to be measured based on the donee’s activities. Berkshire donations are owner-directed and not board member directed or management directed. It’s crazy for corporations to match their employees contributions to charities. It’s the owners of the company who will have to decide.

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Both the directors and managers should act like owners. Most of the companies acquired by Berkshire were family-held companies so they come from an owner perspective and Berkshire sets the right environment for them to work even better.

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An “investor” is not one that buys and sells stocks of far-from-great businesses. Nor can someone have a long-term investment success from flitting from flower to flower. Giving the name “investor” to institutions that trade actively is like calling somebody who repeatedly engages in one night stands a romantic! By spreading too much between businesses that you know little about, you don’t diversify. You should focus on companies that you know the most about, you have clearer picture of the economic long-term prospects.

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Some people say that small individual investors have a disadvantage as opposed to big investment firms with huge leverage (lots of money under management) which can move the markets because of their high trading volumes. That’s not correct. High short-term volatility gives more entering opportunities for long-term thinking investors who want to buy a good company at a low price.

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You don’t only have to find bargains in the market, ie. any companies at a low price, but you have to find the good companies at a low price. When Buffett bought Berkshire Hathaway, that was a textile business. It was a company at good price when he bought it, but he soon discontinued the textile operations are they were not profitable. As he says, that was one of his biggest mistakes and it took him quite a while to understand.

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The value of any stock, bond or business today is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset. – John Burr Williams. It’s easy to valuate a bond but with stocks it’s tricky. You have to estimate the coupons.

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Buffett sees acquisitions in the same way as investing in stocks. Each one is the same as becoming part of the company.

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Buffett invests in company that don’t experience major changes. Because that way you can project the companies revenues in the future. He says: “As citizens we applaud change and innovation. Intelligent investing is not complex, though that is far from saying it is easy.”

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Buffett buys good companies after they get hit by some bad news or when after a bear market. That’s the time when good companies are traded at a low competitive price. Buffett bought more than $1bn worth of Coca Cola shares after the stock market crash in 1987. Coca Cola became his biggest investment accounting for the 6.2% of his portfolio. Since then, Coca Cola grew on average 11% every year. You see, that’s an investment that has been beating the market consistently for more than 27 years. Again, pay attention, Coca Cola is a big company, easily understandable with a product that’s well established world-wide.

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Buffett also bought Apple when it stock suffered a hit in April May 2016. What happened then? Iphone sales went down 16% and Apple had a decline in profits for the first time after 13 years. There were a lot of different reasons explaining this decline some of which were beyond Apple’s control. For example, slower growth in China who is Apple’s second-largest market. Also, a strong dollar put another stretch on Apple sales abroad. Companies like Apple don’t die so easily and it was clear to Buffett that all that was just a storm cloud over the company that would sooner or later go away. It certainly was. Have a look at the chart below.

Investing Myths

I need to be a super genius to make money in the stock market. No, you don’t need to have an IQ of 200 to become a successful investor. Benjamin Graham says that the intelligent investor needs to be patient, disciplined, eager to learn and harness emotions.The ability to stay calm and not sell when the market is hitting bottom, not buy when the market is hitting the ceiling, stick to your strategy whatever your neighbour does, not form an opinion on something that you don’t understand – all these are qualities of a strong character, not a strong brain.

On the contrary, intelligent people often think they are smart enough to fool the market but they are the first to fall prey to their own biases. Isaac Newton was an example of a smart man who lost lots of money in the stock market. Although he made a profit by selling the stock of the South Sea Company (£7000), he re-invested his money in the same stock. The stock of South Sea Company collapsed and in the end, Newton lost £20000 which is equivalent to around $3m today’s money (2002-2003).

I can beat the market. No, you can’t! If you think you have discovered a magic formula that predicts stock future prices based on historical prices, you’re fooling yourself. There have been lots of people who thought they came up with the magic formula. The problem is that it’s very easy to find patterns through any historical data and people are naturally tuned to find patterns (in psychology this is called bias in favour of causal explanations, or cause and effect bias). We don’t want to believe that something is random. If we can’t find the pattern, we think that we lack understanding, not that we’re dealing with some random data.

So, whatever formula you have found that works for the past 5, 10, 20, or 100 years of historical data the future will come to prove you’re wrong. And if we suppose such a formula existed, the moment people announce it in public (something that lots fund managers have done in the past to attract investors), the swift changes in the market dynamics would create such unrealistic expectations that the whole thing would collapse in a matter of seconds.

Now, another important note here. Maybe you managed to beat the market in the short term because you were lucky (yes, it was pure luck trust me). The successful investor is the one who enjoys steady returns in the long term. It makes no sense to beat the market in one year and lose half of your money in the next year. And if you managed to beat the market by taking huge risks, that doesn’t make you a good investor. It shows that you can’t control yourself and your emotions.

Buffett said: “If you risk something important to you, for something not important, that’s foolish. If you give me a gun with a thousand chambers or even a million chambers, and there is a bullet in only one chamber and someone says, how much do you want to pull it once? I’m not gonna pull it. You can name any sum you want, but it doesn’t do anything for me. I’m not interested in that type of a game and there are people doing it financially.”

If I know that a company has great physical growth prospects, it means I’ll make lots of money if I buy its stock. It depends. If not only you but everyone else also thinks the same, the stock price would skyrocket to such level that the company could never keep up with the investor expectations no matter how great the growth prospects. And remember, Buffett says you have to buy a company when it is underpriced: “What is smart at one price is stupid at another.” If you’ve already missed the train, don’t rush to buy high the next Microsoft, the next Google along with everyone else. As Benjamin Graham says, you should dread a bull market as it makes stocks too expensive to buy.

Resources

In this section I’d like to give you a few useful resources that I’ve used since I started investing in stocks. In this chapter, you’ll find different sorts of resources like books, websites, market research tools, live market and stock price tools, etc.

If you want to become a successful investor and be rich you have to read a lot. Warren Buffett said: “Read 500 pages like this every day. That’s how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.” So, be among the minority who will do it and will stand out from the crowd!

Reddit Investing forum

I’ve been using Reddit not only for connecting with other investors but also other like-minded people who want to expand and share their knowledge on any subject. If you have a question, submit a text post in the reddit investing community and you’ll usually get an answer in a matter of minutes. Remember though that these communities can only exist if the participants also give value besides getting value. Contribute to the community. Add value.

Stock Screener – FinViz.com

That’s an awesome stock screener. It’s like an excel spreadsheet with live data. I find this really useful when I want to find top performers for the day in a certain index, cheap stocks, etc. In the screenshot above I have sorted the stocks in the DJIA (Dow Jones Industrial Average) by p/e ascending.

Value Line

Value Line offers accurate market research data. What I love most with Value Line is their one-page free pdf packed with data and insights for all stocks. For example, if you want to get quick access to the one-page pdf for General Electric, just search “General Electric value line” on Google. The first result that will come up is the one-page pdf you’re looking for.

Their one pdf is really handy for someone who wants to have a quick look at the fundamentals, key ratios like Return on Equity, Return on Capital, Dividend Yields, etc. Extremely useful are their insights presented in a few paragraphs. Bear in mind that the pdf doesn’t show the very latest data but they are very helpful for someone who wants to invest in companies for the long term. Also, pay attention that all the figures in bold are only forecasts! You can download a pdf on their website which teaches you step by step how you can really fully their one-page pdf, what each number represents and how it’s calculated. Just search for “How to Read a Value Line Report”.

Market Latest News & Analysis

I know I keep mentioning Warren Buffett in this guide but there is no doubt he is the model investor. And no matter whether it’s investing or anything you’d better be mentored and listen to the best. Talking about market resources and news, wouldn’t it be great to know what Warren Buffett reads first thing in the morning?

Buffett reads the Wall Street Journal, the New York Time, the FT, the American Banker and the New of Omaha. The first three require a subscription plan but it’s worth checking regularly as they do offer special discounts from time to time. For example, you can subscribe to the WSJ for only $1 for three months the last time I checked. If they keep this offer you may cancel and renew using a different email and debit/credit card. I’m saying this because I’ve met lots of beginner investors who understand the value of investing and want to start now even if they don’t have enough capital. So, why not save $30 a month and investing it in shares rather than a monthly subscription plan at the moment that you can get that same information with some little extra effort.

Also, other sites that I love are the classic Investopedia (they are lately adding new resources and videos every day), Moneyweek, Marketwatch, Seeking Alpha, and Tipranks.

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More on when’s the right time to invest

There are those who believe that one should buy only in a bear market. I do agree that the best time to buy is when stocks have hit bottom and everyone else is selling them to save whatever’s left. I do agree that a bear market is a time you should see gold when everyone else sees doom. I am writing this in March 2018 following a period of almost eight years of a booming bull market. Have a look at the S&P 500 index chart below to see where we are now.

It’s clear that stocks are expensive. Most of you are wondering whether it’s a good time to buy now. In my opinion, if you’re investing for the long-term you should get invested even now. The more you hold the stocks, the more they correct bad performance periods. I’d like to direct you to this recent video of Warren Buffett who is bullish even at this point when the stocks are expensive. His rationale is the following. There are companies out there that are growing at 10-15%. Why would you not buy equities now and prefer safe bonds which give a 2-3%? You see, he didn’t say anything about market prices; he talked about company earnings growth. That’s a real value investor.

At the end of the day there are companies out there that are not overpriced. Maybe giants like Amazon are overpriced and that’s the reason this graph above is skyrocketing but you still can focus on other companies/sectors that are not so expensive. You can still find good companies.

In any case, as here we are in favour of buying a whole index rather than individual companies, it is still safe to enter the market now because you simply can’t time the market. No one can. If you decide to wait, that may take forever. Remember past performance doesn’t indicate future performance. The stock market has no memory. Don’t look for patterns. It’s erroneous to say that we have economic cycles every ten or fifteen years, so I’d better way for a couple of years. Don’t get into this rationale.

Some of you would argue that Buffett has to keep buying whatever the market does as money keeps coming in from his shareholders. It’s a job of a financial manager to keep allocating the money that people trust him to promising companies that will generate profits. And there will always be companies that will be generating profits whether the market is going up or down.

In a bull market, you can work hard on your savings and invest in short-term government and corporate bonds if you can’t afford to suffer a short-term loss in case the market starts going down. In any case, you should be always drip feeding into equities and be more aggressive when others are fearful.

Moreover, you should always be making a list of good big companies that you would like to invest like Coca Cola. When these companies have suffered big losses because of the general pessimism of the market, you should be ready to invest in them. A tip is to check the dividend yield. If you see the dividend yield rising up to 4% or more for a company with a steady yield around 2-3%, that’s a time to buy it. The yield is going up since the share price is falling down. If you see a great blue-chip company (a company with a big market capitalisation = total number of shares * share price) losing 20%, 30% or more, go invest in it.

Quick Tips for Researching a Company

Below are my favourite tips from the book The Intelligent Investor by Benjamin Graham on how to spot good businesses.

1. Download and go through annual reports of the previous five years or so. Make sure you understand fully how the company makes money. Public companies (whose stock you or anyone can buy) are obliged by the regulators of their country to publish reports and financial statements like balance sheets, cash flow and income statements. If we’re talking about an American company, you can download its annual reports (Form 10-K) at www.sec.gov. Public companies also publish their reports on their websites.
2. Beware of companies that keep acquiring other companies by buying their stock. Why would you want to invest in a company which doesn’t know how to grow and instead keeps buying other companies to make money. Companies often pay a high premium to acquire others and all these costs show on the company’s balance sheet as non-recurring cost. But, think for yourself. If a company is a serial acquirer, wouldn’t it be not correct to call acquisition costs operational costs! At the end of the end day, this is how this business is making money – by acquiring other companies!
3. Beware of a company which continuously reports cash from financing activities in its annual report. This can make a company look like it’s growing but the thing is that cash is coming from borrowing and at some point, this debt has to be paid back. A healthy company should be reporting lots of cash from its own operating activities.
4. Beware of a company which generates all its profits by doing business with only one customer. For example, a software company which is only making billing software for a telecom operator. What if the telecom operator goes bankrupt?
5. Good companies have a moat as Warren Buffett says. Have a look at companies with tremendous intangible assets. How much would one pay for the recipe of Coca Cola’s flavoured syrup? The moat could be economies of scale. Well-established companies produce products at a very low cost per unit because of their huge production. How much does it cost Gillette to make a razor as opposed to a new company that wants to enter this market? Would you start a new company to compete with Gillette? In other cases, the brand name is so strong that it’s identified with a product itself. For example, Kleenex, Scotch tape.
6. Beware of companies with huge growth. It’s impressive to see a company grow at a 20% or 30% but how long can a company sustain this rate of growth for? The market prices reflect the growth prospects. Just like a share price is growing faster than a company’s growth rate, the share price will end up falling faster than the company’s falling growth rate, that is, share prices grow faster than companies but share prices also plummet faster than companies. Look for smoothly growing revenues and profits over a long period of time. A guideline is 10% pretax growth, 6-7 after tax. Even 15% growth is too much.
7. Beware of companies that spend little or nothing on research and development as well as those who spend too much. Maybe a good company has a great competitive advantage that places it far ahead than all the competitors but still, a healthy company should aspire to grow, ie. spend some money on R&D. On the other hand, a company that doesn’t give any dividends and is reinvesting everything into the business is not a good candidate to invest in either. Take for example companies in the semiconductor industry which keep reinvesting in order to stay in the business and keep their market share.
8. Beware of managers who can foresee the future. Good management focuses on growing the business rather than the share price. Good management delivers on their words and promises. Check annual reports. Did the management do what they promised to do? Beware of management whose words and rationale is in direct correlation with the trends and mood disorders on Wall Street. Good managers don’t blame the economy, the uncertainty, the competition. How much does the CEO get paid? Warren Buffett’s most acquired businesses used to be run by already successful wealthy managers – family owners who were always driven by their passion for the business rather than money. Check Form 4 in the company reports which shows whether managers keep selling or buying shares in the company. Does the company keep cancelling or repricing existing stock options for their management? That’s ridiculous and treats shareholders as fools. A good management should focus on preventing the share price from skyrocketing or plummeting. Big words and predictions of quarter earnings don’t help towards that direction. Also, managers are not TV personas who spend most time on TV panels.
9. Check the Cash Flow Statement. Is cash coming from pure business operations? Does this company produce more and more cash every year? Warren Buffett introduced something called “owner earnings”, that is, if you were the owner of a business how much money would you have in your pocket after one year? A great resource on how to calculate the owner earnings can be found here.
10. How much long-term debt does the company have? Warren Buffett invests in companies whose long-term debt could be paid back with earnings of 4 years or less. What sort of debt does the company have? Are the rates fixed or variable? Long-term debt should never be more than 50% of the company’s total capital. To the long-term debt, you should be always adding the preferred stock. Preferred stock is a higher class of ownership on a company’s assets and earnings than common stocks. Preferred stocks usually pay fix dividends to its holders before dividends are paid out to common shareholders.
11. The stock that outperforms the competition in good and bad times is a sign that managers make good use of cash. If the stock doesn’t perform well, it may be because managers refuse to pay dividends. Also, another practice that should make you worry is constant stock splits. Management enters this practice of splitting a share into two. However, a share that’s worth $100 has the same value as two shares of $50. Remember that when your stocks get double through splitting, all the other shareholders’ stock gets doubled. Hence, you don’t own more of the company. It’s like cutting an 8 piece cake into 16 identical pieces and getting 2 pieces instead of a ⅛ piece. If they split the stock just to make it more desirable, they don’t add any real value.
12. Beware of company management buying stock at a high price. That’s the worst waste of the company’s earnings. Managers that want to cash in on their stock options follow this tactic quite often.
13. Read the company’s annual reports backwards. Whatever the management doesn’t want you to know is usually hidden in the end. And never forget reading the footnotes!

 

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