How to Start Investing – Part 2

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Last time, we talked about the risk of cash only vs. investing plus an emergency fund in cash, getting started with an app such as Trading212 to begin your investing journey, and finally we spoke of one of the essentials of investing – diversification. We promised to talk about how to choose stocks in the next post, so here we are: analysis time!

Stock analysis has its own history and there are various methods and tools we can use to analyse stocks. But first, we have to think about why we are investing. Are we looking to replace our income so we can retire or go part-time at work? Are we looking to grow our wealth for some important event in the future, perhaps a car, a wedding, or a house deposit? Are we looking for a combination of these? Are looking to do this for ourselves or for someone else such as a child or grandchild?

All of these questions are really important because they may govern what type of account we open as well as what type of stocks or other investments we choose to buy and sell. Once you know the answer to these questions, you can start to make a plan. As we are in the UK, I am using examples from here, and specifically from England & Wales, however there will be similar schemes or accounts in other countries, as always, DYOR.

The next thing to do would be to choose an account to invest in such as an ISA or a SIPP. ISAs are tax free, however if you’re working you will likely be then investing from money that’s already had tax and NI taken out. Otherwise you may open a SIPP, in which case you will receive tax credited back to your account every time you deposit money. This will be 20% of the total and then if you’re a higher or additional rate taxpayer, you can claim back another 20 or 25%. So if you pay in £80 it’s like paying in £100, because the government give you back the £20 it assumed you paid in tax.

Importantly, even if you’re unwaged e.g. you’re a housewife, student, etc. you can still get this benefit, although you have a limited about of £3600 (correct at the time of writing) which you can deposit per year. Always check your own situation with the latest information e.g. via Money Helper – which is a free and impartial service.

So, now we know what we’re saving for, what type of an account we need, and we understand the basic principle of diversification via industry, we can start looking at how to analyse stocks. We will look at a couple of examples:

1. Someone investing for an even in the future e.g. wedding, house deposit
2. Someone investing to replace their income

Looking at no. 1, this person is looking to grow their wealth and then sell off their investments in the future to pay for something particular. They may not intend to keep any of the investments, or they may only be taking a lump sum out here or there. This means that they want to look for investments which will grow in value over time, preferably in industries or sectors where lots of growth is possible. For example, a tech company is more likely to have growth opportunities than a supermarket such as Tesco.

The grocery market in the UK is already the most competitive in the world, margins are razor-thin, and now Aldi and Lidl have started eating up the market share of Tesco, Sainsbury’s, etc. This is why the large supermarkets also sell insurance, savings accounts, homewares, clothes, and offer schemes such as Nectar and Clubcard. Tech on the other hand can grow because of the nature of change and development, the fact that anyone can use a computer or phone anywhere in the world, and that it is an easy industry to get into. It’s far easier to learn programming and invent an app or website offering some kind of online service than it is to establish a new supermarket!

So all this means that when investing, the person from no. 1 is not likely going to concentrate on buying shares in Tesco stock, but they might buy instead buy shares in a tech stock that offers services to the grocery industry for example. Using some general knowledge of industries, we can therefore make decisions like this which will narrow down our range of options in which to invest.

Another aspect to think about is whether a stock pays a dividend or not, and if so, how much in terms of % per year? And does the company have plenty of money to spare so they can pay out the dividend and still have plenty left over? Dividends are a bit like the stockmarket equivalent of interest on the cash savings account. They are a monthly, quarterly, biannual, or annual payment back to shareholders. If you are investing for growth, dividends become less important to consider, because the ultimate goal of our person no. 1 above is to sell off the stock at a higher price in the future. Most companies pay dividends, but some only pay a tiny % whereas others pay a higher yield. For example, Apple pays a dividend of 0.54% (correct at the time of writing) and British investors will pay 15% tax on that, however British American Tobacco pays a dividend of 10.21% and if held in an ISA, there will be no tax to pay.

As we can see from the two stocks above, a tech stock versus an old industry essentially shows us growth potential vs. income potential. We assume that Apple shares will increase in value over time, whereas tobacco shares might not. In this case in particular, tobacco is subject to much government regulation so these companies are diversifying their own operations into other industries such as farming, food processing, etc. whereas Apple does not need to do this. It is unlikely that the government will suddenly ban mobile phones or iPads, whereas buying and smoking is already severely restricted in the UK. This is another element of risk to be aware of – what affects industries and sectors in terms of government regulation. DYOR and look various industries in which you may be interested to see how they’re affected by rules and how competitive their industry or sector is.

In example no. 2 someone is looking to replace their income in which case maybe they do want to look at companies paying a solid dividend yield – as long as they can maintain the payments of course, otherwise your income replacement plans might just go out the window! They will also want to think about how often the dividend is paid – most stocks in the UK pay a dividend twice a year, but it’s not an equal amount, instead it is an interim (smaller) and a final dividend (larger) payment usually ~6 months or so apart. Some investments, such as Shell, pay a quarterly and a tiny handful pay a monthly dividend.

Regularity of dividend is important because it can accelerate your income goals, meaning you can add the dividend to your regular deposit more regularly than if you have to wait for an entire year, which is often the case for French and German stocks, this means you compound your income at a faster rate.

Using tools and services to analyse stocks

Now we come to a really important part – the use of online tools, books, and services to help with stock analysis. I mentioned before that stock analysis has its own history, and it would be remiss of me not to mention a few books which may be useful, the first of which is Security Analysis by Ben Graham. This is the most famous of all books on how to analyse stocks and it has stood the test of time, with several editions being printed over the years and now new authors and contributors have updated the original 1934 text with commentaries and adjustments relevant to the 21st century.

Another book which may be useful to you is the FT’s Guide to Investing which has also been updated and is the bestselling book in the UK about investing. Case studies and examples have been updated and this book is now up to its fourth edition since first publication. Either of these would give you a solid grounding in understanding investments and I myself have read several books on investing and they were all worth the money spent.

Online stock analysis

There are several websites and software packages that can help the personal investor in their goals. Many of them are US based however, so don’t necessarily cover UK stocks or at least aren’t written in terms that are relevant to the UK-based investor, however that’s not to say they aren’t useful. I am just going to mention the ones that I have used and why they may or may not be suitable for you.

This is not a comprehensive list, obviously, but I hope it has given you a flavour of what’s out there. There are, of course, paid for services and some of the above have pro level access. There is also software such as SharePad/ShareScope which has been winning awards for decades and is highly praised by everyone who uses it due to its ease of use and comprehensive data going back 20+ years. It’s also cheaper than most gym subscriptions at £32/mo (correct at the time of writing) so for people with the financial savvy and enough interest in running their own portfolio, it’s a popular choice.

In the next blogpost, we will look at some of the key data points to consider when deciding whether to invest in a stock e.g. market capitalisation, dividend yield, dividend cover, and more! If you have any questions or comments, please feel free to leave a comment below.