This is going to be the ultimate guide on what you should learn first starting from knowing absolutely nothing about investing to becoming an investor who can beat the market indexes. It doesn't matter if you invest in penny stocks or blue chips. The principles are all the same.
This is an opinionated guide. If you just want a resource unopinionated guide then check out this github:
https://github.com/ckz8780/market-toolkit
I will update it constantly in the future.
- There are no capital requirements to investing. In fact you should start learning as soon as possible because it takes time to become proficient at investing.
- This guide is only for fundamentals as I specialize in fundamentals and not day trading, technical charting, cryptocurrencies or forex trading.
- This guide is tailored towards people who want to individually pick stocks, if you solely do ETF's or index investing this guide is still useful to you but not aimed at you.
- Investing should be done with disposable income. NOT with income you need such as rent money.
- If you aren't willing to put in the time and effort that investing requires to beat the market indexes then you should stick to passive investing and just buy an index fund and forget about it for 20 years. This requires 0 effort but you will never beat 8% a year on average and because you lack experience you may panic and sell at times when you shouldn't.
To start off I would recommend watching this overview video, it quickly goes over the main stuff by legend investor Bill Ackman:
Bill Ackman: Everything You Need to Know About Stocks
Then you should start reading, lots of reading and no big amounts of investing. You have to read books from other fundamental investors to have an idea of how they did it and the decades of accumulated experience of investing they have poured into that book. It's important to read the right books from authors who have a track record of beating the market, not just anybody. I have ordered this list in terms of ease of reading for newbie investors as well as priority:
These 3 are all easy books for a beginner to get their feet wet and start off with some solid fundamentals. The harder books will come later.
A share of stock is NOT a lotto ticket. It is a part ownership of a business
P/E ratio can be thought of as the number of years to earn back your original investment. IE = P/E of 10 would be 10 years assuming earnings stay constant. Ratios tend to be lower for slow growers and highest for the fast growers with cyclicals in between depending on the current cycle.
Look at average P/E ratios on the company you are researching and peers going back several years to determine if it is a good buy
Avoid stocks with HIGH P/E ratios. They must have incredible earnings growth to justify the price
P/E ratio that is half the growth rate (annual earnings) is very positive and one that is twice the growth rate is very negative. IE = P/E of 10 should be growing at 10%
Formula = Growth rate plus dividend yield divided by P/E. IE = 12% growth + 3% yield/10 P/E = 1.5. Less than 1 is bad. 1.5 is ok and 2+ is great.
The stock market as a whole has its own collective P/E ratio, which is a good indicator of weather the market at large is over or under valued. If some stocks are selling at inflated prices relative to earnings, then it could be likely most stocks are selling at inflated prices.
Interest rates have a large effect on p/e ratios as investors pay higher p/e when interest rates are lower and bonds less attractive
Dividend paying stocks keep the stock price from falling as far as if there was no dividend
You CAN'T predict future earnings. Wall Street has battalions of analysts trying to do this and they are wrong a lot.
Cash Flow – amount of money a company takes in as a result of doing business. You want to buy companies that don't need to spend a lot of money to make money IE = company spends 20 million to make 100 million is better than one that needs to spend 90 million to make 100 million. Formula = $20 stock with $2 per share annual cash flow has a 10-1 ratio which is standard (10%). $20 stock with $4 CF = 20% return on cash. Focus on free cash flow – what is left over after normal capital spending is taken out
Debt to equity ratio - normal is 25% debt to 75% equity but higher equity % is better
Investing is all about reading financial statements and understanding how to read them such as the 10-k, 10-Q etc. Pick any company, it doesn't matter which one but I recommend that you pick a simple company that you already use and know.
Income Statement
Statement of Cash Flows
The Balance Sheet
3. Intrinsic Valuations
The most important part of this section in my opinion. If you understand how to intrinsically value a company then you understand when to buy and when to sell a company based on its real value.
These differ from relative valuations such as the ratios (PEG, PE etc) because here we are trying to find the intrinsic value to a company and NOT the relative value compared to its peers. This is an important difference, for example in the 2001 dot com bubble you could have valued an insanely overvalued internet stock with a relative ratio such as Price-Operating-Cash-Flow and you may have found it to be better than its peers. Just because it's better relatively than its peers in its industry does not mean a company is fair value.
Discounted Cash Flows Models
The reason a lot of people do not like DCF's is because:
They do not understand how to do them properly.
The resources online are absolutely terrible for DCF's, most use CAPM (in my opinion, a completely flawed way to calculate your WACC).
The templates are confusing.
Here are some resources on how to do your own DCF's:
tracktak.com (Free) (error)
I now use the above tracktak link for all my DCF's that you see me post here, it's based off of Aswath's spreadsheets but automates the majority of it for you so you don't have to manually fill in every single input.
The reason why I like these DCF models are because they are easy to use (Aswath explains how to use the excel template it in his video) and it does not use the flawed CAPM model for calculating the WACC.
Dividend Discount Models
An alternative way of getting the intrinsic value of a company. I do these very rarely so I'm no expert on them. I hope to update this section in the future with more details.
4. Relative Valuation Ratios & Technical Terms
There are tons of financial terms and ratios to learn such as PE, PEG, ROIC etc. The way to go about this is to learn these ratios as you go when you encounter them in a book or your valuation and not just all at once. Investopedia usually has good explanations and videos of every term.
The most important ratios and relative valuations in my opinion are:
- Revenue
- ROIC
- WACC (not the CAPM Version)
- Price-to-operating Cash Flow
- PEG
The most useless financial metric by far that way too many people use is the PE ratio, it is easily manipulated by accounting shenanigans, fluctuations in short term reporting and reinvesting companies such as Amazon. The PEG ratio also suffers from this but is better as it factors in growth.
5. Psychology of Investing
You should work on your own psychology to investing as soon as possible when you start investing. This will allow you to not panic sell during dips and crashes or FOMO (Fear Of Missing Out) during market rallies.
This is perhaps the most overlooked section, most investors never bother to get their psych in order which is a big mistake usually because of overconfidence of their own abilities.
You should learn how to use screeners to narrow down stocks within your circle of competence and to the ratios that you learned about in section 2. You want to screen for stocks that have below a certain threshold in x ratio, for example `PEG < 1` which will screen all stocks for you that have a PEG of less than 1 (A PEG of < 1 is theoretically undervalued...sometimes). It's best to combine multiple ratio's together to really narrow down to a select few companies to look at. This saves a bunch of time in finding potentially good companies.
The ratios I like to use were all mentioned in section 2.
Screeners dump:
Screeners I personally like best:
The easiest way to make money long term in the stock market is to simple buy undervalued stocks, this ties into value investing. It's a simple concept where if you buy something undervalued then sooner or later the market will realize it's undervalued and correct accordingly (most times, sometimes it can stay undervalued forever). A lot of people mistake value investing for price to book ratio or some trash ratio like that, value investing is simply the concept of buying a stock for less than its intrinsic worth (i.e a margin of safety).
You must read the following books:
These are the staples of value investing and what Warren Buffet read multiple times. They are difficult and long books to understand at first which is why I have put them in the 6th section so don't worry if you don't understand everything at first.
To be able to read Financial Statement numbers you really need to know how accounting works, both for GAAP (U.S) and IFRS (Most of Rest of World).
The reason why you should know accounting is not only to spot red flags in financial statements but also to understand the downsides of accounting. For example, only recently in 2018 were companies required to include Capital Leases in their balance sheets liabilities. Before then, companies could hide it in Off-Balance sheet statements that few people looked at, grossly inflating the viability of some businesses with heavy lease requirements.
David Krug's courses are an in depth full courses on accounting. You may not have the time to learn accounting in full though so if you do not then I would recommend the Accounting 101 course which fast tracks you to learn only what you need for our purposes.
Howard Schilit's book will give you a good overview into the most common financial accounting tricks that you can try and spot.
This section is completely optional and not necessary but allows you to fine tune your assumptions.
So monte-carlo simulations are simulations that run thousands of times on your valuation models (such as your DCF model) to simulate multiple cases in your models. So instead of just doing a bear case and a bull case in your DCF model you can run a monte-carlo simulation and give your boundaries for your inputs (e.g 25% with a std. deviation of +/- 5%) and you will get a range of different outputs, in our case estimated prices per share and then you can use the mean price as your estimated price per share.
One of the ways I find new stocks to look into is by reading blogs and posts about undervalued stocks. Here's a couple that I like:
Well... if you've made it this far then congratz. It's a lot to learn, basically a full time job to learn all of it. And that's the point, if it was easy everyone would be rich.
A final point is that a lot of the above links are from prof. Aswath Damoradan. The reason is that I have found him to be the absolute best source of information in regards to valuation ever and everything he publishes is completely free.
Thanks!
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