I was 21 when I placed my first trade. There’s so much more I know today that I wish I knew back then and you too should definitely be looking to arm yourself with as much information as you can before you place your first trade. There’s no way we can cover everything you should know about share investing in a single article so this will be a multi-part series. This new series will specifically cover trading and investing in publicly-listed companies. If you’re new to investing I highly recommend you click on the little Menu icon on this site and go to the Investing 101 tab where you’ll find some useful introductory articles (if you can only read one, check out Diversification and ETFs).
What are shares and how can I trade them?
A share is an interest in a company. When you purchase a share, you’re essentially purchasing part ownership of a company. Your shares may come with the right to vote on company matters and they may come with rights to receive dividends. Dividends are profits that a company periodically passes onto its shareholders. Shares are also called stocks or equities (I use all three terms to keep you on your toes).
You can buy and sell shares in any publicly-listed company. Publicly-listed companies trade on securities exchanges like the Australian Securities Exchange, the New York Stock Exchange, the NASDAQ or the Financial Times Stock Exchange. You buy and sell shares through a securities broker (you may have heard terms like CommSec, Robinhood, Stake, Plus500, SelfWealth, IG Markets etc). This article isn’t about ETFs but know that you can also find ETFs on these securities exchanges.
Types of companies
There are loads of companies listed on securities exchanges all over the world, each with their own functions and goals. Three very general umbrella categories you can divide companies up into include:
- Value stocks: These are stocks that might be undervalued (trading at a price less than fair value). When we say undervalued in this context we mean undervalued according to company financials. For example, the company may have a very low P/E ratio (more on this in another installment of this series). One reason why a good quality stock may be undervalued is because some external event that had nothing to do with the company caused a major sell-off (see for example how the share prices of some big name brands plummeted at the outset of the COVID-19 pandemic, only to quickly recover when investors started to cool down).
Valuing a stock is almost impossible. There are well-researched, high quality financial valuation models out there but even the experts often get it wrong. It’s not a perfect science so you’re not always going to be able to accurately categorise these companies (and it would be negligent of me to share an example).
- Growth stocks: These are stocks where the primary focus is, as the name suggests, growth. These companies haven’t set making money as the top priority, instead focusing on investing a lot of profits back into the company and growing the business as quickly as possible. The majority of growth stocks are companies which offer the market a new and innovative method of achieving something. This is why most of these stocks tend to be in the tech sector.
Growth stocks are typically riskier than value or income stocks as they’re often in growth stages or have very little cash to spare, spending as much as they can on growing their production capacities or consumer bases. Examples might include Tesla, Amazon or Afterpay.
- Income stocks: These are stocks with stable, ongoing dividend payouts. Not all companies pay dividends because it’s not compulsory and because all companies have different goals, but income stocks are characterised the way they are because they do pay dividends. Many people, in particular retirees, use dividends to finance their livelihoods. Examples might include AT&T or CBA.
A very common misconception about shares is that a company’s share price is a reflection of its total value. Many people think for example that Google is worth more than Apple because 1 share in Google costs a little shy of 2,000 USD and 1 share in Apple costs a little less than 140 USD. To truly understand how much these companies are worth you have to multiply their share prices by the number of shares they have on issue. Not all companies have the same number of shares on issue. The result is what’s called a company’s market capitalisation. If you do this you’ll learn that Google is today worth around 1.3 trillion USD and Apple is worth almost double at, 2.3 trillion USD.
As a very general rule of thumb, the smaller the company is (smaller market capitalisation), the more likely it is to be a risky investment. Large cap companies in the US such as Apple, Microsoft, Google and Walmart or in Australia such as CBA, ANZ, CSL and BHP are highly unlikely to go under. Small or micro-cap companies on the other hand are riskier companies. These companies have a harder time trying to secure lending and trying to appeal to cashed-up investors like fund managers so if they start to show signs of stress, it’s very difficult for these companies to find outside support, which makes them more likely to go under.
Loads more to come but for now and forever, remember, birks will never not be awful.