People often look for a second source of income to have as a backup option. After all, who doesn’t mind a few extra bucks? There are many ways to do so, like freelancing, blogging, etc., but most of them will require putting in extra efforts. Hence, a lot of people choose to invest their money and enjoy the returns. There are various financial instruments that can help you achieve your desired returns but one of the most intriguing one among them all is ‘the Stock Market’.
The stock is a unit of ownership in any business. If you own a stock, you own a certain small fraction of that company. And consequently, a stock market is a place where stocks of various listed companies are bought and sold. The prices of stocks are changing all day long based on a number of factors. In reality, it is impossible to quantify all the factors that influence a stock price, let alone be able to predict the exact price the stock will be worth. Yet there are some factors which can help us make an intelligent guess and we will be discussing some of those factors here. The following methods are used for investing in long term:
Knowledge Required: Basic Accounting knowledge, ability to read financial statements of different companies.
Company performance is one of the factors that influence the price of its stocks. A good performing company may not necessarily have an upward trend or an increasing price at all times. Sometimes, a company may take on loan for a particular project’s investment and weigh down. Therefore, the scales of liabilities on its financials, increased debt, or non-performing debts, usually are a sign of declining company performance but not in every case. As in our example, the loan is an investment in a project which can be profitable and have almost twice a return on its investment. Hence, there is more to financials than a simple increase in debts or assets.
Investors use tools for determining company performance. These tools, known as ratios come under the methods of fundamental analysis. By seeking different accounts in the financials, ratios are made which can give a simple output on the basis of which decisions can be taken regarding investment. There are many ratios but two standard ratios used, which are recommended for beginners as well are:
– Earnings per share: Ratio of company’s profit to a number of outstanding shares, EPS is a measure of a company’s profitability. The higher the value, the better option the company is for investment.
– P/E Ratio: Calculated as market value per share divided by EPS, it is an indication of how much an investor is willing to pay to earn $1. A high P/E ratio usually means that investors are willing to pay more mainly because they are expecting growth in the company.
Knowledge Required: General understanding of latest happenings in news.
Another factor that greatly influences stock prices are external factors, which come under technical analysis. Political riots, technological advancement, etc. are some of such external factors. These factors cannot always be quantified but having knowledge about these can give us an intuition as to the trend the price is likely to follow; a political event in favor of a country can boost stock prices in general. Whereas, a technological discovery can impact technology sector more. Some such external factors which impact particular stocks, a whole sector or complete stock market, are as below:
– Inflation or deflation
– Substitute products/services of a company
– Political Events
– Liquidity of stocks (invest in actively traded companies)
– Demographics of investors
Knowledge required: Thorough understanding of notations used in stock tickers.
The stock market is a combination of various stocks and a market itself exhibits certain trends based on the continuous trading going on during trading hours. The prices are constantly fluctuating of active stocks due to selling and buying happening in large volumes. These spontaneous trading are often influenced by collective emotions of traders that as described by behavioral finance, is one of the major factors for price trends in the market. There are two periods which are a consequence of market emotions:
– Bullish period: during this period, there is excessive buying of stocks in the market, due to which the prices of stocks go up and the market follows a general upward trend.
– Bearish period: during this period, there is excessive selling of stocks in the market, due to which the prices of stocks go down and the market follows a general downward trend. It is usually a consequence of a bullish period as a market suffering extremities balance itself eventually.
Forces that influence the stock prices are uncountable and there is no way to be able to understand all of them at once. But there are some factors that can be kept in mind while choosing companies to invest in. Remember, it is considered a good practice to keep your investment diversified that is, not invest all your money in a single company or sector.