Five stock market tips for beginners

The last three years have been superb for equity investors as stocks have outperformed most other asset classes such as gold, other precious metals, industrial metals, real estate and bonds during the period. The Indian equity benchmark BSE Sensex is up 60 percent cumulatively from the pre-Covid high made in January 2020 and it is up nearly 160 percent from the post-pandemic high made in April of that year.

The stock market had shown some weakness in the 2022 calendar year but stock prices are on the rise once again. 

A continued good show by equity has made it a magnet for young and first-time investors looking to earn much higher returns on their savings compared to what they earn in bank deposits or life insurance policies.

Investment in equity is however fraught with more financial risks than bank fixed deposits, bonds or gold. A wrong investment decision in the equity market can wipe off most of your capital in a matter of days. Given this, beginners or first-time investors should strive to avoid big mistakes.

Here are five investment tips that will help you to avoid costly mistakes and greatly improve your chances of earning high returns on equity investments.

1. Start small: Stock prices tend to be volatile and directionless in the short term and it’s always best to start your investment journey through small installments at a fixed interval, say once or twice a month. This way, any potential loss from an investment in a “wrong” stock will not hurt your financial position or your household budget. 

If you succeed initially in making the right bet, it doesn’t mean you should invest all your money in the market. 

You should only invest the amount in stocks that you will not need over the next two years. 

Secondly, don’t change your investment decision based on daily or weekly fluctuations in the share price of your stocks. In other words, stay invested in a stock for at least a year before you sell it for a profit (if it has rallied post your investment) or you decide to exit if its price has fallen. 

Also Read: Top 5 micro-cap stocks for investment right now

2. Build a portfolio: Equity is a volatile asset and prices can move widely in both directions in the short term. As an investor, you need to protect yourself against these wild swings in prices as they can wipe off your capital. Diversification is one of the best ways to minimise the volatility in the value of your overall investment and create steady growth in your wealth over a period of time. 

The best way to achieve diversification is to invest in a portfolio of 15-20 stocks rather than invest in two or three stocks that may be popular among equity investors and traders at that time. 

At any given point in time, some stocks in your portfolio will do well while others will underperform or even decline in value. But don’t panic; your portfolio will help you smoothen out the volatility in individual stocks and your returns will be closer to the market’s average returns.

3. Invest in sectors and companies that you are familiar with: Common and well-known companies whose products and services we are familiar with or we use on a regular basis make the best portfolio. So start your portfolio-building exercise by buying and holding companies whose business and products they know and have some judgment about. 

The safest way is to start with the market leaders in respective sectors.

For example, invest in the stocks of the country’s biggest carmaker, the top bank or the biggest pharma company or the leading telecom operator. Market leaders most often have the best finances in their industry and their stock prices fall the least during a recession and are one of the first to rally when growth resumes in the industry. However, this doesn’t mean that you should buy the stock of every industry that you know. Be a little choosy or you will end up spreading your capital too thin over a big and unwieldy portfolio.

Also Read: 10 large-cap stocks trading at a discounted valuation

4. Develop patience: It takes time to build a financially successful business; so don’t expect quick returns in stock investment. Do some research before investing in a stock but once you have invested in a particular stock, don’t dump it if the stock price falls or it starts underperforming. 

If you have conviction in your investment decision and are sure about the company’s business fundamentals then give it at least a few quarters to blossom. Also, don’t hesitate to book profits if a particular stock in your portfolio has run up too fast and too soon. 

As a thumb rule, if a stock in your portfolio doubles in value, sell 50 percent of your holding and recover your capital. 

You can invest the money in new stocks. However, if a particular stock in your portfolio has fallen very sharply, say by 50 percent or more, don’t try to average out your purchase price by making fresh investments. It’s never a wise decision to throw good money at bad.

Also Read: 10 large-cap stocks trading at a discounted valuation

5. Learn some standard stock valuation ratios: The two most common variables to value stocks are price-to-earnings multiple, also called P/E multiple, and price-to-book or P/B ratio. P/E multiple is calculated by dividing a company’s latest market capitalisation (or share price) by its reported profit after tax (or earnings per share) during the latest financial year or the last four quarters. A company with a lower P/E multiple is considered to be undervalued and vice-versa.

The P/B ratio is calculated by dividing a company’s share price by its book value or net worth per share in the latest financial year. A stock with a low P/B ratio can indicate an undervalued stock. The P/B ratio is usually used to value stocks in capital-intensive and asset-heavy sectors with volatile earnings such as banks, non-bank finance companies, insurers, metal, mining and oil & gas companies. In contrast, P/E ratios are mostly used to value asset-light businesses such as technology, FMCG and consumer goods manufacturing.

Also Read: Four financial ratios to help you buy the best stocks

Use the valuation ratio to compare two stocks in the same sectors and not across sectors. For example, FMCG stocks always get higher P/E than say steel or cement companies. So a lower P/E for a cement company doesn’t make it cheaper compared to say an FMCG company.

Happy Investing!

(Disclaimer: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist). 

Also Read: Five defensive stocks to protect your portfolio in current volatile market

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