9 essential questions first-time investors must ask before diving into the stock market

As the US S&P 500 blasts through its record high of 4,000, today is an exciting time to invest in shares. Possibly too exciting, as many will probably be sucked into today’s frothy stock market expecting to make quick money, only to come unstuck. Investing is the same as anything else. You have to work at it to make it a success, especially when trading individual stocks and shares. Before starting out, ask yourself these questions. For newbie investors, the answer is almost certainly no. That is understandable but take it easy at first. First-time investors should only start by investing money they can afford to lose, says Samuel Leach, director of Samuel and Company Trading. This also means money you do not expect to need for some time. Your minimum investment term should be five years, but preferably much longer. Too many first-time investors suffer from overconfidence and pay the price. A few big losses will soon clear the head, but do not let it come to that. Armies of traders, fund managers, investment banks and private investors pore over stocks night and day, and the chances of a novice spotting something they have missed are slim, says Jason Hollands, managing director of investment advisory company Tilney. “Do not try to be too clever or confident in your ability to second-guess markets.” Instead, keep it simple. “Look for businesses with great products and services that generate lots of cash and have healthy finances, but do not overpay for their shares,” says Mr Hollands. Diversification is essential to mitigate losses – because you will make them at some point. “If investing in individual shares, you should at least have a dozen holdings,” he says. Finding the best stocks requires a bit of detective work, says Dan Lane, senior analyst at Freetrade. “Ultimately, a company’s goal is to make money and your job is to figure out which companies are best placed to do this.” Start by looking at a company’s finances, says Mr Lane. “How much does it make in revenue and how much of that is converted into profit?” Other questions include: are its products or services in demand? What external forces may influence sales? Do the shares look expensive? Women are far less likely to buy shares than men, yet research suggests they make better investors because they think long term, trade less aggressively and take fewer risks, says Anna-Sophie Hartvigsen, co-founder of Female Invest. Investment company Fidelity Investments examined eight million customer accounts and found women made on average 0.4 per cent more every year, which adds up over time. If you invested $100,000 and generated average growth of 5 per cent a year, you would have $432,194 after 30 years. Generate 5.4 per cent a year, and you would have $484,416, or $52,222 more. Ms Hartvigsen says mindset is everything. “Investing is not about instant gratification but playing the long game. It takes time to see returns on your investments, so be patient.” A common misconception is that you need a lot of money to begin with. “You can invest small sums, then add to them later. The most important thing is to start.” Everybody loves a bargain and that applies to shares as well. “Value” investors seek out cheap shares they believe are undervalued and ripe for a recovery. One way to measure this is by looking at the price-to-earnings ratio, which measures a company’s share price against its earnings. The further this rises above 15, the more expensive the stock is, while something trading at five or 10 times earnings is considered cheap. As an extreme example, electric car maker Tesla now trades at a mind-boggling P/E of 1,223 times its 2020 earnings. Investors are clearly pencilling in rocket-fuelled growth. By contrast, New York-listed Campbell Soup trades at only 15 times earnings. Investors do not believe tinned soup has the same growth potential as Elon Musk’s electric vehicles. Mr Hollands says never buy a share because it looks cheap or reject one because it is relatively expensive. The cheap stock may be a fundamentally poor business, while the expensive stock may be a great one, but tread carefully. “A very high valuation should be a red flag.” Mr Lane says the P/E ratio is no “golden ticket to guaranteed investment success ... It is just one indicator among many.” Company debt is another. Heineken Holding has been hit by falling beer sales in the pandemic. It does not help that it had high net debt of more than €18 billion ($21.8 billion) as of the end of last year. Before buying a stock, check whether it has the edge over its rivals. Market dominance, a strong brand, low costs, loyal customers or high barriers to rival entrants will all help to sustain its position. Last week, Netflix shares dropped by 11 per cent after subscriber growth fell significantly short of expectations. A key reason was that increased competition from the likes of Disney+ has eaten into market share. Netflix also burns cash, spending $3.3 billion on new content this quarter alone to keep up, says Sophie Lund-Yates, equity analyst at Hargreaves Lansdown. “Offering the latest must-watch is crucial as competition is so fierce,” she says. Netflix faces broader threats, such as whether people will still want to sit indoors streaming TV after lockdowns are lifted. Trends change. Stocks and sectors move in cycles. Last year’s pandemic losers could turn into winners. Airlines could rise if we start flying again. Cinema chains could light up trading screens for the right reasons. The big banks could cash in as the economy returns to growth. Invest in what you think will happen tomorrow, not what happened yesterday. The internet is packed with information that can help investors but you need to handle it carefully. Mr Hollands says it is important to beware of following tips on online discussion boards. “You are trusting a complete stranger who may be out to spread disinformation.” However, ratings by brokers such as UBS, Goldman Sachs and Jefferies can point to where a stock price may go in future, says Mr Leach. “For example, Tencent Music Entertainment Group, a joint venture between Tencent and Spotify, has 15 ‘buy’ ratings with no ‘sell’ ratings, which is a positive sign.” The median broker price target is $31, with a high of $38. “That gives substantial room for growth, given that it is currently trading at $18.” Cynics say that buying shares is purely a gamble, and there is some truth in that. Predicting winners and losers is never a sure-fire bet. Lately, though, younger investors have been taking the idea a bit too literally. Many inexperienced investors have been speculating in high-risk shares such as Tesla or hyped-up US retailer GameStop, fuelled by free apps such as Robinhood in the US, says Simon Crookall, founder of online investment service InvestEngine. “Some are simply buying individual stocks or cryptos and hoping for the best.” Instead of chasing speculative bets, Mr Crookall says investors should look to build a balanced, diversified portfolio of shares they understand. “Otherwise, you are diving headlong into choppy waters.” If all that sounds like too much trouble, let the experts do it for you, says Rob Morgan, investment analyst at Charles Stanley Direct. “Actively managed mutual funds and investment trusts, and index-tracking exchange-traded funds allow you to invest in the stock market while spreading your risk across dozens of different companies.” It is time to start investing. But do your research first. Essential questions novice investors should ask before they begin to invest:

9 essential questions first-time investors must ask before diving into the stock market

Investing is not about instant gratification, but playing the long game, financial experts say