Stocks (or shares) are the units of ownership in a company. This unit is then traded in the stock market. When a company needs money, they can request a loan from the investors. A stock investment involves an element of risk; that is, the risk to lose money invested. The amount of risk is dependent on several factors, such as the size of the company, the potential of its product, market forces, the earnings, losses and profits of the company, etc.
In order to minimize this risk, investors should ensure that they have appropriate information about the company they are investing in, the risk factors involved and the financial health of the company. This information should be provided in plain language and easily understandable terms.
They should ensure that they do proper research before investing their money and that they keep their broker informed about the latest happenings in the company's business.
They should make sure that they never entrust their money to anyone who does not have good experience in handling stocks.
Information about the companies the investor wants to invest is supplied by the investor's broker. The broker provides information about the company, including its financial reports, products and services, valuation techniques, profit, loss and projections for the period involved and future projections for that particular stock.
Information about the company is provided to the investor by the broker and the investor decides if he wants to buy or sell stocks in that company. It is his decision and responsibility. The investor is required to keep an eye on his shares. This way, he can decide whether he wants to hold on to his shares or sell them in order to gain profit.
In case the company fails, the investor should take a Decision Immediately. This way, the investor not only knows the risk of his investment but also knows when to get out of the investment. For example, if the company's sales decline by 25% or more in the next three months, the investor should get out of his investment immediately and should inquire into the reasons behind the decline in sales.
The investor should make sure that the company is growing its sales faster than the overall market. It is worth noting that company growth rate should be higher than the market growth rate. It is an accepted fact that when a company is undervalued, its growth rate will be higher than the market growth rate.
The investor should also ensure that the company's return on equity (ROE) is higher than the market return on equity (ROE). ROE is the percentage of a company's total assets that are owned by its stock holders. ROE should be higher than the market ROE.
Investment philosophy: the investor should ensure that his investment is well capitalized before investing. It is necessary to ensure that his investment is fully paid off before investing.
The second component of investment philosophy is to maintain a diversified portfolio. This means that the investor should ensure that his portfolio contains both growth and income stocks. The income stocks should have below average sales returns. By investing in income-paying companies, the investor can gain market exposure.
The last component of investment philosophy is to buy lower-priced stocks at a discount and then sell higher-priced stocks at a premium. This is because high-priced stocks are at an advantage given by the market coverage and the income growth is already reflected in the stock price.
An ideal investor would not focus on any one sector, but have a diversified portfolio of 25% income stocks, 75% growth stocks, 5% neutral stocks, 5% international stocks and 5% other stocks.
The best way to ensure a diversified portfolio is through a financial advisor. He can put in strategies for an optimal portfolio.