Monday, February 27, 2006

Investing in Stocks: Part II

It has been one crazy week! I don't even know where all of the time went between working and class and everything else that life has thrown at me in between. Sorry for the lack of updates...I promise to do better!

Next month, my company is going to hold a training class for the staff on how to begin investing in real estate (i.e. how to buy your first home, whether you should buy a singe family home or a 4-plex, & how to buy a small commercial building). This should be great blog material. Look out for that in the near future.

But let's get back to investing in stocks which is the topic du jour. Now that we've picked an online investment firm, we need to understand what a stock is.

This may sound very elementary but understanding this basic principle is crucial in allowing us to make informed decisions when we invest in the stock market. So please, bear with me!

Basically, when you buy stock you are buying partial ownership of a company and therefore a claim on it's future earnings. The more stocks you own, the more say you have in how the company is run and are the larger your claim is on the company's future earnings (paid out in dividends). The more the value of the company grows, the higher the stock price is likely to go, thus allowing you to sell your stock at a later time for a higher price. Conversely, if the value of the company declines, you will not be able to sell your stock for as high a price as you bought it for and you will lose money (boo).

Therefore, when you buy a stock you want to know as much as you can about the past and future potential earnings of the company so you can gauge how safe your investment is and what the potential for return is. Learning about the past financial history of the company is the easy part. Predicting the future...well that's another story. So let's start with understanding the past.

All corporations are required to issue financial statements to investors at least once a year. Once you are able to read these financial statements you will be able to make a more educated decision on whether or not a stock is a good investment or not. The 4 important financial statements are:

Income statement: Records the revenue and expenses and provides the net income or net loss for the year
Cash Flow Statement: Records where cash is being spent and how they are financing business operations
Balance Sheet: Records all of the company's assets, liabilities and stockholder's equity
Retained Earnings Statement: Records how much of their Net Income was paid out in dividends

Financial statements are available for all companies if you go to NYSE website. Simply go to the "Listed Company Directory" and pull the "SEC Filings" for the company you are interested in.

The information in the financial statements allows investors to calculate different ratios that can measure a company's performance (i.e. Earnings per share and Price-Earnings ratio), track the company's revenues, and see how much debt the company has, among many other things.

Knowing what everything in the financial statements means will probably take lots of time, but reading through even at a high level will give you a greater sense of the operations of the business, how the company intends to grow (if at all), and how profitable the company is.

It can be fun to read through financial statements randomly. I would recommend to think of a product you love, or an industry that you are familiar with and read through some of the annual reports for those companies. You will probably learn a lot!

Next: What to look for in a company...

**Disclaimer: Please keep in mind that I am by no means an expert in investing in the stock market. Quite to the contrary! These are just my general findings as I educate myself on how to invest wisely so please, take everything I saw with a grain of salt. And I'd love to hear your opinions and advice from your own experiences!

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Anonymous said...

I am going to go along with you for the ride on this series. I have 33 shares of PRU that I got because of an insurance policy my parents purchased when I was an infant. I've been wondering if I should try to add to those and knew I needed to do some basic analysis. I will go pull their SEC filings and look forward to your next entry!

Anonymous said...

I'm already lost! LOL There's a lot of SEC Filings! Are you using a particular source of information like a book or website for this series? Thanks!

lpkitten said...

yes, it can be quite daunting! what i did was narrowed it down by filing type. so if you select Filing type "annual report" that narrows it down to 14 results. the first result is the 10-k and is what you are really looking for. you can tell because it says "annual report which provides a comprehensive overview of the company for the past year". i hope that helps!

also, i'm not using a particular book except maybe my accounting text book and what i'm learning so far in my accounting class. i've been "reading" the "warren buffet way" as well as the "little book that beat the market" (i put reading in quotation marks because I am actually listening to the audio book). i'll go into those a little more in the future. they are really interesting.

Debt Hater said...

I'm making a note of all this, but I am trying to kill my debt. I'm wondering though if I should use ALL the extra money I save here and there for the debt, or if I should start investing (at least in a Roth IRA or something) now...

lpkitten said...

def keep attacking your debt! by paying off your debt you have a guarantee on the amount of money you are saving. personally, i'm still contributing to my 401k because my employer will match up to 5% of my contribution. i would say if you receive a guaranteed match from your employer to go for it; if not, i would put it all towards the debt.

even though i'm not able to invest my money now because its all going towards the debt, i want to feel prepared to make my money work for me once i am debt free. :)