Buying Stocks: The Bare Necissities
Updated: Sep 15
What to know about stocks to buy for long-term investing.
*Not financial advice - your money, your choice*
One of the most confusing things in finance is the usage of jargon. They exist to confuse you. The reality of finance is that the majority of it only requires elementary school level math (arithmetic if you want to use jargon). No one except for people who
work in finance or...
have a weird fascination with finance...
know what words like ‘mutual fund’, ‘index fund’, or ‘expense ratio’ mean.
The acronyms are even more confusing, long, and vague (kind of like the movie, Inception): EBITA, EPS, PPE, ETF, and on and on.
Something that I started to hear over and over when I first started investing was ‘buying the dip’. At the time it meant nothing but now I realize it’s the most important buying opportunity that any of us can have.
‘Buying the dip’ refers to buying an asset (fiat currency like US Dollars, cryptocurrency like Bitcoin, stocks like Apple or Microsoft, bond like a Treasury Bond, ETF like VTI, Index fund also like VTI, etc.) when pricing is low. If you're not familiar with words like ETF or Index fund or VTI, click here.
Photo from Google
But how do we know when something is priced well??
One of the best indicators, and what people are usually looking at when "buying the dip" is the 52-week range. This is a metric that tracks the highest and lowest price of an asset in the last year. If something is at the low end of the 52-week range, it usually means that it's relatively "cheap" but anyone who works in finance will tell you that this metric is pretty much bullshit.
Photo from Google
Luckily, this isn’t the only indicator we have. Also important when buying an individual stock is the EPS or ‘earnings per share’. This represents the money that the company made divided by the number of shares that exist and is typically the marker of a company with good cash flow.
Ex: Imagine you have a super successful gourmet cookie shop, we’ll call it ‘Crumb’. Because it was quite expensive to start, you have 2 other business partners and you each have an equal stake in ‘Crumb’. You’ve decided that ‘Crumb’ will start with 1,000 shares and because you each own a third, you each have 333.33 shares. During the year, ‘Crumb’ brings in $100,000. This would mean your EPS would be $100,000/1,000 = 100; that is an EPS of $100 per share.
Something you may notice right away is that a lot of companies have millions or even 10s-100s of millions of shares. Because there are so many shares and they can only make so much money, most companies have an EPS of much less than $100 per share.
This means that if a company has an EPS of $100 per share it doesn’t necessarily mean that it's a better company than one with an EPS of $10 per share - the more important part is that it’s positive and increasing over time.
Confusing!
Another metric we can look at is the PEG ratio. And no, it's not what you're thinking. It has nothing to do with cribbage.
The PEG ratio is a company’s Price/Earnings ratio divided by its earnings growth rate over a period of time (typically the next 1-3 years).
This metric can be helpful to adjust companies that have a high growth rate and a high price to earnings ratio. A low peg ratio of a fast-growing company, around or under 0.5 for example, represents a company that may be 'cheaper' when it's growth rate is taken into account vs a company with a peg ratio of 0.8 that's growing at a slow rate.
One of the risks of using the PEG ratio is that it only looks forward 1-3 years which is a pretty short time horizon in the world of stocks. This typically means there may be more risk involved.
There are many other metrics but we'll leave it at those 3 for now...
Beyond most metrics, it's extremely important to pay attention to the leadership team. If they have a sketchy history then tread with caution; new ventures aren't always going to be different.
A similar idea applies to the amount of conviction that you have in the future of the company itself and the ideas that are driving the company. If I don't believe that a company has a future or if the leadership has a history of fraud/not performing then I divest or don't invest in the first place.
This post aside, it's important to remember that buying individual stocks is risky business; not too dissimilar to gambling especially if you're trying to make money over the short term. I always prioritize low cost broad market index funds that offer reduced risk through diversification and have historically good performance.
You can find more info on how to do this in the second half of this article.
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