When you Buy a Stock, you are Buying a Business
People often forget about this.
The act of purchasing a stock is often times reduced to looking at the price of a stock. Does the price go up or does it go down? This price fluctuation is what most people are fixated on.
There are many attempts being made to guess the price action of a stock on a daily basis. If you go to a brokerage firms’ online site, you will find many tools that help you do so. The “indicators” that is often used are:
and so on.
Now I am not here to make a comment regarding these tools’ ability to help you make money in the stock market. In the context of the equity market, however, I do personally think that some time can also be spent in understanding the very basic.
Basic #1: What are you buying actually?
Actually, you are being a piece of paper. No kidding. In the olden days before smartphones and digital brokers, you are actually buying a piece of paper. Here’s an example of one:
Now this paper represents how much a company is worth. Literally, how much the company is worth is very simple to calculate that is:
company's worth = price per share * number of shares
With this knowledge, go ahead and find how much your favourite company is worth:
Let’s say you bank with BCA or Mandiri
Or you eat Indomie every other month
Or you buy a Toyota car from Astra
and so on, you can calculate how much that company is worth using the calculation above.
Basic #2: What determines the price of one share of a company then?
Many things. Why? Because it is a free market and people have all sorts of reasons on why they sell a stock:
For retails, it might be because they need more money for a rainy day
For fund managers, it might be because they are overweight in a certain stock and they need to sell a little bit so that their portfolio composition is more balanced.
For investors, it might be because the company is not performing as well as they expect
For traders, it might be because the price has crossed the threshold of the many indicators (discussed in the first section)
The list goes on. With this many unknown factors, trying to predict the movement of the stock price is a non-trivial task. Predicting it accurately 100% of the time for all stocks warrants suspicion.
So what to do?
If the price of the stock is subjected to forces that are incredibly uncertain in nature, what do we do? We go back to the basics.
We try not to look at the price too much, but rather the company. There are basic factors that make a company investible.
Factor #1: Who controls the company?
People forget that when we buy a share and become an owner of a company, we are the minority, unless you do a tender offer. Minority is always at the mercy of the majority.
For us to have conviction, we need to understand that behind a company, there are people who produce a product or service that offers value in exchange for money and profits.
To deliver exceptional product or service, it often requires:
Experience & Expertise
Imagine if a donut company is run by an expert cyclist. That donut would probably taste like Tour de France (apologies for the lame joke).
Imagine if a company serving thousands of clients only have one guy doing the job (no collaboration). Probably it will take ages for the one guy to serve everyone.
Imagine if a company only sells their product once in a while the owner feels like it. Perhaps they will not be maximising the potential.
Imagine if the company has an appetite to take large debt from banks without a clear business plan. Then that company would sooner or later be tied to paying interest to the banks instead of their shareholders.
Factor #2: Is the company growing?
Definition of growth is simple. Is the company making more and more money over the years. If it does, then it is a growing company. Otherwise, either it is stagnating or declining.
Now it is always remember to always check the growth and ensure that it is real. There are common accounting gimmicks (future blog post idea) that can give an impression that the company is growing real fast. Common methods include:
Selling of an asset
Revaluation of an asset
and many more
Factor #3: Is the company issuing dividends?
While this boils down to investors’ preference, companies that issue dividends offer plenty of merit because it takes away more components of speculation.
For example, when you purchase a residential property, you can choose to rent it out or to keep it still. If you are not using it for a long time period, perhaps it makes sense to rent it out to tenants. This is because if the property value goes no where, at the very least you will receive a steady flow of income from rent fees.
So you can think of buying a stock similar to buying a property. If you buy a stock that issues dividends regularly, it is akin to buying a property that is rented out to people.
If you are a trader, you should look at the price using the many indicators shared above. Price x is cheap or not depends on indicator y.
If you are an investor, remember that buying a stock is buying a slice of other people’s business. Knowing that price of a stock is heavily dependent on uncertain human behaviours. It can be severely discounted or severely overpriced based on the value of the company. We can determine “the value” with these basic factors that are really simple and intuitive to grasp:
All these factors would give you a nice picture to determif that company is worth your money or not for the long term.