Welcome back to Taaza Facts Finance! In this Blog, I will guide you on how to Make Money in Stocks for Beginners in 2024, step-by-step. Whether you are a beginner or an intermediate trader, you will find valuable information in this Blog. I have been investing in the stock market for 5 years and have a finance degree and an entrepreneurship degree. I have also worked in finance and commercial real estate. Now, let’s get started!
Why Invest in the Stock Market?
- The stock market has been one of the best tools to grow wealth over time, with a historical average annual return of roughly 10%.
- Savers are losers. Investing in assets is better than sitting on cash, especially in the current interest rate environment.
- It has never been cheaper to invest, with zero-dollar trades and low expense ratios for solid investments with index funds and ETFs.
- You do not have to be a genius to invest. There are strategies that can help you grow your wealth over time.
What is Stock?
A stock is simply a share of ownership in a company. When you buy shares, you own equity, or ownership shares, in a company. For example, Microsoft has 7.56 billion shares outstanding, and each share represents a slice of the company’s ownership pie.
Understanding Market Capitalization in the Stock Market
Market capitalization is the value of a company’s outstanding shares, calculated by multiplying the number of shares by the share price. For example, Microsoft’s market cap is 1.633 trillion dollars (7.56 billion shares x $216.02 share). Market cap is an important measure of a company’s size and is subject to change as share prices and shares outstanding change over time.
Why Do Companies Issue Stocks?
Companies issue stocks to raise money for their business by giving out shares of their equity pie.
Equities are stocks offered to the public in an IPO (Initial Public Offering) to raise funds for the business, which could be used for a new product line, research and development, or investing in growth. Companies may also do stock buybacks to reduce the number of outstanding shares or pay off debt.
There are two types of stocks: preferred and common. Preferred stock has no voting rights, while common stock has no voting rights but is last in line for payment in the event of liquidation. When buying stocks, as a newbie, you are usually buying common shares.
Stocks are categorized as large cap, mid-cap, and small-cap. Large-cap companies are those with 10 billion or more in market capitalization and are typically well-established with a proven track record. Mid-cap companies are valued at 2 billion to 10 billion and have a more established track record than small-cap companies. Small-cap companies are valued at 300 million to 2 billion and are younger, seeking aggressive growth, and typically higher risk.
Stocks can also be categorized as growth, income, or value. Growth stocks have big potential for growth, outpacing the market, but typically offer low or no dividends. Income stocks pay regular dividends, while value stocks are undervalued and seen as unfavorable in the marketplace.
How many Stock Sectors are there?
The 11 stock sectors are there –
- Energy
- Materials
- Industrials
- Consumer Discretionary
- Consumer Staples
- Healthcare
- Financials
- IT
- Telecom Services
- Utilities
- Real Estate
Finally, risk is the chance that the actual outcome will differ from the expected outcome, and investors are compensated for the amount of risk they take.
Investing in stocks comes with a certain level of risk, including the chance of losing some or all of your investment. As an investor, you are compensated for the level of risk you assume. Different types of risks include:
- Market risk
- Liquidity risk
- Concentration risk
- Credit risk
- Inflation risk
- Horizon risk
- Foreign investment risk
When it comes to buying equities, there are several options:
- Individual stocks
- Mutual funds
- Index funds
- Exchange-traded funds (ETFs)
- Real estate investment trusts (REITs)
Individual stocks are shares in individual companies, such as Walmart or Netflix. The pros of owning individual stocks include reduced or no fees, complete control and understanding of what you own, and easy tax management. However, diversification can be difficult, and it takes time and effort to monitor your portfolio and do your due diligence.
Mutual funds are pools of money from the public to buy securities or assets. The pros of mutual funds include liquidity, diversity, and professional management. There are many options, including balance mutual funds and fixed mutual funds. However, fees can be high, and you have less control over the investments.
Index funds are passively managed funds that seek to match the performance of a specific market index. The pros of index funds include low fees, diversity, and simplicity. However, they offer less potential for outperformance compared to actively managed funds.
ETFs are similar to index funds but are traded on an exchange like an individual stock. The pros of ETFs include low fees, diversity, and flexibility. However, like mutual funds, you have less control over the investments.
REITs are companies that own and operate real estate properties. The pros of REITs include high dividends, liquidity, and diversity. However, they are subject to interest rate risk and can be affected by real estate market downturns.
Investment Options: Mutual Funds, Index Funds, ETFs, and REITs
When it comes to investing, there are numerous options to choose from, including mutual funds, index funds, ETFs, and REITs. However, each investment option has its pros and cons.
Mutual Funds
Pros: Income-producing, actively managed, and many options to choose from.
Cons: Higher fees, not FDIC-insured, large cash holdings, and hard to make comparisons.
Index Funds
Pros: Low fees, passively managed, typically outperform active management, easy to own and manage.
Cons: Lack of control over holdings, lack of downside protection, and limited strategies.
ETFs
Pros: Access to many stocks, extremely low expense ratios, easy to own and manage.
Cons: Actively managed ETFs have higher fees, a lack of downside protection, and limited diversification.
REITs
Pros: Historically inaccessible asset class, stable cash flow through dividends, and access to physical real estate.
Cons: Dividends are taxed as regular income, subject to market risk, and high management fees.
How to Evaluate a Company
When buying stocks, it is essential to evaluate a company thoroughly. Financial ratios play a significant role in the evaluation process, and there are five different financial ratios to consider:
- Valuation ratios
- Profitability ratios
- Liquidity ratios
- Debt ratios
- Efficiency ratios
One of the most popular valuation ratios is the price-to-earnings (P/E) ratio. This ratio compares a company’s share price to its earnings per share, showing the relative value of a company’s shares. The formula for the P/E ratio is the market value per share divided by earnings per share.
Understanding Stock Metrics Using Microsoft as an Example
In this article, we will be discussing various stock metrics and how they can be used to analyze a company’s stock. Using Microsoft as an example, we will look at the PE ratio, PEG ratio, price-to-book ratio, return on assets, return on equity, and current ratio.
PE Ratio
The PE ratio is the market value per share divided by earnings per share. A healthy PE ratio historically was 15 or lower. However, Microsoft’s current PE ratio is 36.38, indicating that it may be overpriced.
PEG Ratio
The PEG ratio is the company’s share price divided by its earnings per share growth. A healthy PEG ratio is typically between 1 and 2. Microsoft’s PEG ratio is 2.49, indicating that the company may be overvalued.
Price Book Ratio
The Price book ratio is the company’s market cap divided by its book value. A healthy PB ratio is 3 or lower. Microsoft’s PB ratio is 13.66, indicating that it may be overpriced.
Return on Assets (ROA)
ROA is a profitability ratio that shows how profitable a company is compared to its assets. A healthy ROA is 5% or higher. Microsoft’s ROA is 16.2%, which is considered good.
Return on Equity (ROE)
ROE is a profitability ratio that measures how efficient a company is at generating profits. Microsoft’s ROE is 40.7%, which is considered high.
Current Ratio
The current ratio measures a company’s ability to pay short-term obligations. A healthy current ratio is 2 or higher. Microsoft’s current ratio is not provided in the article.
Understanding Financial Ratios
Financial ratios can provide insight into a company’s financial health and performance. Here are a few key ratios to keep in mind:
- Quick Ratio: This ratio measures a company’s ability to pay its current liabilities without needing to sell inventory or secure additional financing. The formula is current assets divided by current liabilities. A healthy range is typically just over 1 to about 2, with a higher number indicating a better ability to liquidate quickly.
- Debt to Equity: This ratio measures a company’s financial leverage and is calculated by dividing total liabilities by total shareholders’ equity. A lower ratio is generally considered less risky and more attractive to investors.
- Asset Turnover: This ratio measures a company’s ability to use its assets to generate sales or revenue. The formula is total sales divided by the beginning assets plus the ending assets divided by two. A higher number is preferable, indicating that the company is effectively using its assets to generate revenue.
Keep in mind that these ratios are just one tool for evaluation and should be used in conjunction with other factors to make informed investment decisions.
How to Buy a Stock with Robinhood
Robinhood is a beginner-friendly platform that can help you get started with investing. Here’s how to buy a stock:
Step 1- Download the Robinhood app and sign up for an account.
Step 2- Search for the stock you’re interested in and click on its ticker symbol.
Step 3- Click on “Buy” and enter either a dollar amount or a share amount.
Step 4- Review the market price and place your order.
Step 5- Keep in mind that stock prices are constantly fluctuating based on market demand and supply. It’s important to do your research and make informed decisions before investing.
In the stock market, the bid is what bidders are willing to pay for a share of stock, while the ask is what sellers are asking for their shares. To make a trade, a buyer and seller must come to an agreement on a price.
Robinhood allows users to buy and sell stocks in dollar amounts or shares. Market orders are executed at the current market price, while limit orders allow users to set a specific price at which they would like to buy or sell a stock. Stop loss, stop limit, and trailing stop orders are more advanced trading strategies.
To buy a stock, a user can place a market or limit order. If a user wants to buy a certain dollar amount of stock, they can go out to several decimal places to buy a fraction of a share. Robinhood provides clear explanations of the order details before executing the trade.
To sell a stock, the same process applies. A user can place a market or limit order to sell their shares at the current market price or a specific price of their choosing.
Buying Stocks: Market Orders and Limit Orders
To buy stocks, there are two ways: market orders and limit orders. For beginners, a limit order is recommended. To place a limit order, click on the carrot, figure out the price you want to pay multiplied by the shares that you want, and then set it as good for the day or good for cancellation. If you want to do a market order, you can do the same thing in dollars or shares.
Ramifications and Taxable Events of Buying and Selling Stocks
When you buy and sell stocks, there are two different things that can happen: capital gain and capital loss. A capital gain is when you sell for greater than what you bought it for, while a capital loss is when you sell for less than what you bought it for.
Short Term Capital Gain or Loss
If you made a transaction within one year, this counts as regular taxable income. Your tax bracket determines the percentage you will pay on that capital gain.
Long Term Capital Gain or Loss
If you held the equity for longer than one year, it is a long-term capital gain or loss. This is taxed differently and typically more favorably depending on your income tax bracket.