The entire purpose of investing is to spend money now so that you will receive more money in the future. Typically, the two ways of doing this is through the receipt of future payments such as coupons from a bond, or dividends payed out through the ownership of stock. The other way is through capital gains, which is what I will be addressing today.
The golden rule of capital gains is buy low and sell high. What you buy is a matter of preference. Some people buy commodities such as corn, or gold, or oil. Others buy stocks. If you choose to buy stocks I think it is important to remember that when you buy stock, you are BUYING SHARES OF OWNERSHIP in a company. Think of it as purchasing a little piece of a giant corporate pie. If you are buying shares of stock for anything other than this purpose, then you are speculating or trading, NOT investing. There is nothing wrong with that, but it is important to know the difference.
Many people throughout history have felt that corporate interest have been at odds with the interest of the people and that these two opposing forces are forever engaged in some type of perpetual war. Your typical "rich vs. poor" argument. What people fail to realize is that even the poor can easily align their own interest with that of the big corporations by purchasing shares of stock in those corporations. Next time you feel (or hear about) "big oil," or "big pharma," or any other such "big," might be taking advantage of the little guy for profit, you may wish to consider purchasing some of their stock, and with modern investing tools you can even purchase fractions of shares (in case you can't afford a full one). Now, I don't encourage people to invest in things they feel are unethical, but I do encourage people to take the necessary actions to ensure that it is YOUR pockets that are getting fat and not just "evil big business." The best way to do this is through ownership.
When purchasing stocks for the purpose of capital gains, the golden rule is "buy low, sell high." This being the case, I would ask you if the stock represented in this chart, priced roughly at $92 a share, would be a good buy or not?
If you answered yes or no, then you answered incorrectly. The reason this is so is because you do not have enough information yet! Charts only provide you with a PRICE, but they tell you nothing of VALUE.
A huge part of investing is understanding group psychology. Though individuals can be intelligent, you need to understand that people tend to do what other people are doing, and this tendency leads to some pretty stupid behavior. It is this tendency that creates the boom/bust cycles that we see. The key to successful investing is taking advantage of this tendency by realizing it causes other investors to sell shares far below their actual value and buy shares for far more than they are worth. In order to take advantage of this, you MUST be able to approximate a companies value!
Now if I told you the above stock earned $6.78 per share over the last year and typically traded at 28 times earnings per share (EPS)? Would this stock price then be considered "low" ($6.78x28=$189.84)?
Truthfully, you still don't have enough information, because EPS share numbers are very easy for companies to manipulate. But you certainly have a better idea than you did with just the chart.
Now what if I told you this company had $24.89 per share worth of cash lying around? What if they had no debt? What if this company had been growing it's annual earnings at a rate of over 70% for over five years? And what if I told you that they were producing some of the most popular products around (you probably own one of their products)?
Hopefully by now you can see this stock might be worth purchasing! And though actual stock valuation is a bit more complicated than this, sometimes companies are priced at such screaming bargains that they are hard to miss for those who know how to look. It is for these reasons that I emphasize the importance of being able to determine a stocks approximate value (valuation is more art than science) when investing.
If you are interested in learning valuation, I highly recommend the following books:
Value Investing by Bruce C. N. Greenwald, The Intelligent Investor by Benjamin Graham, and Security Analysis by Benjamin Graham and David Dodd
The last book is boring, dry, and over 900 pgs., but the other two aren't that bad, and they are definitely required reading if you intend on doing this stuff on your own. If your head has already exploded all over your computer screen and you have absolutely zero desire to read a bunch of books so you can figure out what companies are actually worth... then scoop your brains back into your head and fear not! There are multiple ways to invest, and many of them require much less work. But value investing (what this method is referred to) is one method that has achieved rather consistent results since at least 1934.
In case you are wondering, the stock used in this example was Apple from December, 2008.
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