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How to make money in the stock market? – A brief overview/primer on investing (value-approach)

• First, how does someone make money from the stock market?
  • If companies earn a profit, and if you own a piece of a company (what a stock represents) then you are entitled to that piece of its profit & earnings. TLDR; Stocks = ownership of companies/and their earnings

•  How to make money in the stock market/how to find good investments?
  • Find profitable quality companies/stocks; the more profitable the better… or find those with a lot of profit potential in the future, ideally both (predicting the future is impossible, but you can make reasonable guesses) and find the companies that will continue to exist/retain its competitiveness for a long time (not go bankrupt or fade out)
  • Buy them at discounted/good prices; no matter how great your company is or how profitable/growth prospects are, If you overpay for your investment you risk loss and never earning your money back (or at best you may break even)
    • How do you know if you overpaid? If the price of the company (stock) is worth more than the future profits it can earn you in the foreseeable future (I.e. The price of the company/stock today cannot justify the value it can make in the future) (a Discounted Cash Flow model can help show this, using estimates)

•  How do you find Quality Companies?
  • Look for sustainable competitive advantage; will the company continue to exist in 3,5,10 years? Will it retain its market share and position? Will its product go obsolete? Are they taking on too much debt (i.e. if a rough period/economy happens) can the company tough it out or might it go bankrupt? How will the company grow? How is its competition etc? How it’s brand reputation, pricing power, etc.
  • Look at its Financials. How are revenues growing? How are its profit margins, are they growing or declining? How about its expenses (the cost to make a product, admin, and employee, etc) in relation to how revenues are growing by %? Are they overpaying?  Are they good at managing them as the company grows? Do they have too much debt? 
  • How is management (Primarily looking for good track records and to avoid any scandals/dishonest teams/people) difficult to assess, so less emphasis on this. Ideally, a company business model/competitive advantage should be good enough that “even a monkey could run it”.
  • Etc…. a myriad of other indicators that tell a story about the company

• How do you know if an investment/stock is selling at a good price or bargain?
  • Price to book value ratio (how much is the company selling for, compared to how much you would get if you were to sell everything/all its assets today)
  • Price to Earnings ratio (how much X is the company selling for in relation to how much it earns in 1 year). Another way to frame this is, if you pay 7x of what a company makes in a year, (all else equal) it’ll take 7 years for the company to earn back what you paid.
  • EBITDA Multiple (how much are other companies actually willing to pay for a company like this/how many times of earnings, if they were to acquire/buy it? Based on the recent acquisition and sale prices of companies similar) (Think home prices what other people in the neighborhood have recently bought or sold)
  • Etc.. + other metric indicators

• Why do stocks go on a discount?
  • The stock market is not perfect; sometimes fears are overblown/people may be too pessimistic when in reality it’s not that bad. Or vice versa, people can be too optimistic about a company’s future and in reality, it’s not as good as expectations
  • Large opportunities for investing occur during big events that affect how people view or feel about things and the world. During times of uncertainty, people tend to play it safe, and so they pull their money out of the stock market so they can have cash and not see their money be so volatile. When a lot of people are selling out, prices of stocks/companies can sometimes become cheaper than what they’re actually worth
  • “Value is what you get, price is what you pay”

• How do you avoid losing money?
  • Circle of competence; stick to what you know or what you can understand. If a business model/revenue streams/products are too complex for you, it’s likely you can’t make an accurate assessment and therefore intelligent investment. And by avoiding what you can’t understand you avoid risking your money by not “gambling” taking on chances on what you are not informed about
  • Not overpaying
  • Avoiding bad quality companies (see of the opposite of quality companies)

• The easy way out:
  • If this seems like too much time and effort; it’s because it is. And there’s no guarantee you’ll do well. Statistically, you’ll do worse by trying to actively invest. It’s a patience and temperament game.
  • What is recommended for virtually everyone is investing in index funds/ETFs: 
    • Ticker symbols: VTI, VOO, SPY, VTSAX… are all great places to start
    • On average you’ll make 6-10% a year on these for minimal time and effort commitment and is by far the recommended route
  • But if you’re still interested in the active/value investing approach, some good books I’d recommend for a better breakout of these concepts:
    • The Intelligent Investor – Benjamin Graham
    • The Little Book on Value Investing – Christopher Browne
    • Poor Charlies Almanac – Charles Munger