Stock Market Investment Basics

As promised in my last post, I will begin talking about stocks/shares for the next month or so. Before we set off, I always like to remind folks of the need for proper education and research before you drop a dime in any investment or business. The know-how in any business gives you a strategic and competitive advantage.

“An investment in knowledge pays the best interest.” — Benjamin Franklin

Robert Allen in his seminal work, Creating Wealth said that education is the shortest distance between poverty and wealth. He is right and here we are not just talking about academics. Education has taken many forms since when he wrote the book. I will extrapolate this thought to investing — if you do not educate yourself on it, you will be blown away by the many winds that blow on investments.

Let’s go right to stocks. I will start with the very basics.

A stock is a share in the ownership of a company. Stock represents a claim on the company’s assets & earnings, and also a willingness to share the risk that the company is involved in. If you own a share in a company, it means you have a stake in the company. If a company has 1,000 outstanding shares and you have 100 of the shares, it means you own 10% of the company.

When you register a business with the Corporate Affairs Commission (CAC), you will have to state those that own the company and their shareholdings. This shows those who are responsible for the risks and rewards in this endeavour.

Public companies have hundreds or thousands of owners. Each owner contributes a little towards the capital of the company. This contribution is represented by shares. As the owners of a company, the shareholders are entitled to dividends, and are also entitled to vote at the Annual General Meeting (AGM) of the company. Holding a company’s stock means that you are one of the many owners (aka shareholders) of a company and, as such, you have a claim (albeit usually very small) to everything the company owns. Yes, this means that technically you own a tiny sliver of every piece of furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company’s earnings as well as any voting rights attached to the stock.

Let me list out the type of shares.

Common Stock: When people talk about stocks, most times, they are referring to this type. In fact, the majority of stock is issued is in this form. Common shares represent ownership in a company and a claim (dividends) on a portion of profits. Investors get one vote per share to elect the board members, who oversee the major decisions made by management. Over the long term, common stock (not just any stock though, you have to use a number of indices to make the selection), by means of capital growth, yields higher returns than almost every other investment. This higher return comes at a cost since common stocks entail the most risk. If a company goes bankrupt and liquidates, the common shareholders will not receive money until the government, banks, creditors, bondholders and preferred shareholders are paid.

Some companies have classes of their common stocks. One class has more value, voting right and other privileges that the other class. A good example is Berkshire Hathaway. They have Class A and Class B shares. Class B shares are worth 1/30th the value of a Class A share.

Preferred Stock: Preferred stock represents some degree of ownership in a company but usually doesn’t come with the same voting rights. (This may vary depending on the company.) With preferred shares, investors are usually guaranteed a fixed dividend as long as the company is in business. This is different from common stock, which has variable dividends that are never guaranteed. Another advantage is that in the event of liquidation, preferred shareholders are paid off before the common shareholder (but still after debt holders). Preferred stock may also be callable, meaning that the company has the option to purchase the shares from shareholders at anytime for any reason (usually at a premium).

Stock Categorization

Depending on how investors view and classify them, some stocks fall under the following group. These stocks do not always remain in this group perpetually. As they fit the descriptions of the group, they move from time to time. The classifications are below:

Blue Chip Stock— Don’t worry you’ll never see any stock listed on the market as a blue chip but the characterization of these stocks is that they are shares of large corporations with long outstanding and stable histories. They pay dividends regularly and progressively grow, though not in quantum leaps, from year to year. They provide a safe haven for investors who are risk averse, as they offer safety and reliability, and as thus are perceived as quality stocks. They are stocks of well established companies having stable earnings and less extensive liabilities.

The term, blue chip, was derived from casinos, where the chips coloured blue represents counters of the highest value. Most fund managers have blue chip stocks in the core of their investment portfolios. Examples of such stock on the NSE are Nigerian Breweries, GT Bank, Flour Mills, etc.

Growth Stocks — These stocks have good prospects for growing faster than the economy or the market in general. Most times these companies reinvest their earnings and are sometime leveraged (run the company operations using debt) to a good extent. When investors take a stake in these companies, they expect continuous capital gains, hence the adjective growth. This is why you see many people invest in technology start-ups. In these companies, growth is preferred over profitability.

Income Stocks — The companies that have characteristics of an income stock usually pay out a much larger portion of their profit (PAT) in the form of dividends to their shareholders. The companies seem to have reached a pace of growth that is rather slow and the business sometimes is no more expanding. To counter balance the effect of not rapidly growing, a good part of profit is paid to investors as dividend. This makes these shares general less risky to own than shares of growth or small company stock. Though shares of income stock aren’t expected to grow rapidly, their dividend payout acts as a kind of cushion beneath the share price. Even if the market in general falls, income stocks are usually less affected because investors will still receive their dividend. In my opinion, CAP and Fidelity Bank are stocks that fall under this category going by their activities in the recent past.

Cyclical Stocks — They are so called because their fortunes are intricately tied to the economy. They tend to rise and fall with the economy at large; prospering when the business cycle is on the upswing, suffering in times of recession. Overseas, the automobile companies are a prime example. People tend to buy more cars when the going is good, but when the down times present themselves, sales of cars plummet. In Nigeria, the building and construction sector would fall under this category. Sales of building material and more construction contracts are done when the economy is good. When the economy is depressed, survival becomes priority and they tend to focus on that. Same for downstream oil companies.

Defensive Stocks — They are theoretically insulated from the business cycle and are thought to be immuned from the changes in the economy. People still go on to procure their products and services in bad time as well as good. Companies in the food and beverage sector of the NSE fit this bill. People will always eat whether the economy is good or bad. Same as companies in the pharmaceutical / health care sector.

Value Stocks — These stocks are considered to be priced lower that their intrinsic value. They form the basics of what Warren Buffet buys. When compared to their peers, they seem to be “healthier” in valuation but lower in price. More like, there is value locked in the stock. Many indices are used to evaluate what a value stock is. We will get to that later.

Speculative Stocks — These stocks represent young, untested companies that either has just been listed on the market or some old company that is showing some signs of rebounding following either a new government policy or the promise of a new technology breakthrough. The entrance of a new management could make investors envisage a bright future for the company. Investors buy speculative stocks with the hope of hitting a home run (big profit) with it. It is generally known that speculative stocks may not do well on the long run, most times, so it’s a risky venture buying them. It’s also good you have the stomach to bear with the market when things happen in a way you did not expect. In English, that means that the risks are high.

You can check other articles I have written on money / finances / financial intelligence. They are The Money Question 2018 Edition, Saving The Pennies, I’ve Got Money On My Mind, Money & Money Management Skills, and Money Mistakes To Avoid

Some Announcement

1. Please follow me on twitter with the handle @gabomin. Pls don’t forget to retweet (RT). I am very active on twitter to spread the word on financial intelligence

2. I will be conducting a financial seminar on stock market investment that will span for two weeks online (Skype, WhatsApp, Twitter, Videos etc) beginning on October 27th by 12 noon. We will have an online class, followed by videos that will make and send. We will have an interactive session afterwards and a private audience to ask me questions. I can bet you one thing; if I don’t know, I will tell you I don’t. No fake eye lashes. You are getting the real deal. Pls register here https://docs.google.com/forms/d/16zuHputoU6PNRGqlDW3j_5vIe3jLneXq62V5XhayRBI

3. As per the financial seminar, please reach out to me for the fees. If you have my mobile number, better, if you don’t, then you can reach me on gabomin@yahoo.com

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