The reason many people do not invest in the stock market is because they believe stock investing is equivalent to gambling. This implies that investing is a zero sum game, where somebody has to lose for somebody else to win and no value gets created. However, this is an absolutely wrong notion.
It is proven that you can make consistent profits in the capital markets if your investment decisions are backed by proper research. This is because when you invest in stocks, you are in essence providing capital to the most efficient and productive company. This company will use the capital to generate higher returns and profitability. Thus, the overall pie increases for all investors.
The strategy based upon buying stocks with low P/E ratios is called value investing. Benjamin Graham is often named as the proponent of buying stocks trading at low price-to-earnings or P/E multiples. Conventional wisdom would indicate that lower the price compared to earnings, the better the deal. However, picking the cheapest stock available may also mean picking up a business with the worst growth prospects. There may be a good reason why the stock is trading cheap.
Most people just can't resist a good bargain and tend to purchase stocks that are trading near their 52 week lows. Buying a falling stock can have the same effect as trying to catch a falling knife: You may get hurt, almost every time. When a stock falls, investors need to research the reasons for the fall. Is the decline only due to market sentiment, which may reverse; or is the fall due to some significant event which may hurt the financials of the company? Also, just because a stock has seen a sharp rally, does not mean it cannot appreciate further. The reason for investing should not be biased by the rise or fall in the stock price. The buy/sell decision should always be based on proper analysis of the intrinsic value of the stock.
When it comes to investing, there is a belief that one can pay any price for expected growth. This was the reason why we saw the tech bubble at the beginning of this millennium. However, fast growth companies can trade at abnormally high multiples and just investing based on the growth prospects of the company may result in the purchase of highly expensive stocks. Investors should value securities based on fundamentals. If they are not competent to conduct this exercise, they should take the help of experts to help them with the valuation process.
Investors need not have money to make money, but rather need to be disciplined. Regular investing of smaller sums over a long period can unleash the power of compounding and make millionaires out of ordinary investors. Regular investing also results in cost averaging over time. So, it takes hard work (to research good stocks) and disciplined investing to make money in the stock markets.
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