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Factors to consider before trading stocks

As a trader, you should understand the reasons why you are selecting one stock over another. So what factors tend to influence sentiment towards a company? And what should you keep on your radar when trading stocks and shares?

The sheer number and variety of stocks available on global bourses is overwhelming. From tech stocks on the Nasdaq to banking, mining, energies, retail, pharmaceuticals and many others, there is no shortage for traders. For new traders wanting to buy stocks, it can be a little overwhelming. Fortunately there are several useful guidelines to follow as you search for viable investment opportunities.

Why have you decided to invest in this stock?

From the get-go, it’s important to understand your rationale for buying the stock of any company. What is it about the company that catches your interest? You can’t simply purchase stocks based on a romanticised perception of a corporation, the brand, or the type of people that work for a company. Your feelings about products, services or people are secondary when it comes to investing your hard-earned money.

Consider for a moment that even the world’s finest company would make for a poor investment if you overpaid for its stock. So look first to the bricks-and-mortar fundamentals, including management, stock price, profitability, earnings and cash flow.

Emotion-based investments are the wrong investments, period. Similarly, speculative investments may yield profits but they can’t form the basis of a long-term strategy. For intelligent investment, the best stocks to purchase are those that are undervalued or fairly priced.

Do you understand the pricing of the company?

Everyone can understand how much any individual stock is selling for, but do you understand how the company is priced? What would it cost you to buy the entire company? In other words, what is the market capitalisation of the company you’re looking at?

Quite simply, the market cap is the stock price multiplied by all outstanding stocks at any point in time. A company with 100,000 shares at $100 per share has a market cap of $10 million. Meanwhile a company with 10 million shares at the same price has a market cap of $1 billion.

The per-share price gives you little information in itself – since it gives no indication of the total value of the company. Small-cap companies typically have a value under $1 billion, medium-cap companies under $10 billion, and large-cap companies over $10 billion. The market cap therefore gives you a much better indication of the company’s overall value in the marketplace.

How long are you going to hold on to this stock?

Your investment timeline will vary depending upon your motivation for buying any particular stock. This in turn determines your investment strategy.

For maximum yield you’d be looking at a minimum investment period of ten years. The reasons for this are simple: dollar cost averaging, reinvestment of dividends back into the company stock, and allowing the stock sufficient time to appreciate in value.

The long-term strategic approach is to purchase a high-quality stock at a low price and allow the passage of time and the expertise of top management to drive up the company’s profits.

By contrast, short-term strategies focus on topical factors affecting share prices. Make sure you know which approach you are taking.

Do you understand the effect of per-share growth?

One undervalued aspect of investing in a company is the importance of per-share growth. Consider that a company could generate identical profits year after year but give increasing returns to investors simply by reducing the volume of outstanding shares.

With each additional share a company offers on the market, your share as an investor becomes less and less of the company total. Accordingly your percentage of the disbursed profits will continue to shrink as more stocks are offered for sale.

In other words it is always best to select a company that focuses on the reduction of outstanding shares. This makes your interest in the company greater. Hence, you are likely to receive more when profits are paid to shareholders.

The fewer the number of outstanding shares in the company, the greater your stake in its profits and asset holdings. Any company that promotes shareholder wealth creation is a better investment than one that simply wants to sell as many shares as possible.

Making the case for stock investments

Before you part with your hard-earned money it pays to ask yourself the following questions. Why are you investing in the stock? What gains do you hope to make? When do you want access to your principal and profits? Where do you feel your money is best invested?

With the answers to these questions, and a clear trading plan in place, stocks can form a valuable part of your investment portfolio.

Brett Chatz

Published: 15 July 2015

You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.

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