Stock Investment Framework

Investing in the equity market can yield tremendous returns (Stock Investments Singapore). Many friends and relatives I have spoken to do not have a stock trading account or have stopped investing in the stock market, often citing the following reasons:

  • have been “burned” before
  • it is risky
  • don’t know how to invest

It is indeed important to know the “rules of the stock market” and note that when you buy a stock in the stock market you are buying a business/company and becoming a shareholder, hoping the company will do well and give you good returns.

Stock prices move up and down but companies which perform well, grow their earnings and dish out impressive dividends over the long run will see their stock prices move up over time as well.

Buyers and sellers trading in the stock market actually engage in a zero-sum game, for every winner, there is a loser. You want to be the winner most of the time.

5-Step Stock Investment Framework

Stock Investment Framework

Getting properly educated in stock investment is thus important. I offer the above 5-step stock investment framework. By itself, the steps are quite common sense but each involves picking up the right knowledge and skill sets.

I will be quoting Warren Buffett extensively through this discussion (in quotes).

  • Stock Screening – There are many stocks listed in every stock exchange. How do you go about hunting for the right ones to pursue. “Invest only in companies you know and trust”. Each of us is trained in a particular field, work in a particular sector and we have our own circle of competence. That’s definitely a good area to start with. Other considerations include whether you want to go for big market cap or small market cap or which stock exchange.
  • Fundamental Analysis – This step involves dissecting the company, understanding if it has a great economic moat, if it has a good management team to steer the company in the right strategic direction and delving into its financials such as earnings strength, profit margins, cash flow positions, return on equity (ROE), debt level etc. “It’s far better to buy a wonderful company at a fair price, than a fair company at a wonder price”.
  • Valuation – To me this is a very key step but sometimes the calculations can be daunting. You want to know the intrinsic value of a particular stock and there are a number of valuation methods available, from a simple look at the PE ratio to such concept like the Discount Cash Flow method. “Price is what you pay. Value is what you get”.
  • Market Entry – A stock price lesser than the intrinsic value you have computed should signal you can start buying the stock. However, you might want to build in a margin of safety (MOS), a term popularized by Benjamin Graham, Warren Buffett’s mentor. Calculations are not going to be exact, so allow some margin of errors. “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1”.
  • Market Exit – If a company is always growing or always consistent in generating a great level of earnings, then in theory, you will never want to sell it. Review your stock portfolio regularly and take actions when there is some change in the company’s fundamentals or the price has really gone up too high. “Our favourite holding period is forever”.

Stock Investment Is Not For Everyone

Believe me that stock investment is not very complex. Having said so, it does take efforts. You need to be properly educated, either by reading some good books or attending some good courses. We do our research when buying a car, a smartphone, furniture for our house. You need to do the same if not more when buying a stock.

If you admit you are too lazy to do so much research and analysis, you can still benefit from the stock market by investing into market index ETF, an article I have previously shared.

I will briefly discuss Technical Analysis (TA) and Options Strategies which could be additional tools to supplement your investment framework.

Options Strategies

Technical Analysis

Value investors may not focus so much on technical analysis when deciding when to buy into a position; and technical analysis may be seen as more of an art than science. I do appreciate benefit of some simple technical analysis pertaining to support and resistance to decide a better entry point.

This is a good optional area of expertise which can be incorporated into your stock investment framework.

Options Strategies

Options on stocks (puts and calls) can also complement the direct buying and selling of stocks. An elaboration of this will be an article by itself, so suffice to say once you have mastered the 5 Steps, you can consider learning and using options to improve returns on your stock investments.

Stock investment requires patience and is not a get-rich-quick scheme. As a conclusion, I would like to quote Warren Buffett again. Often times, I can manage the investment framework processes well, but the emotional side of things is harder to control. I buy favourite stocks without factoring in MOS and exit without good reasons.

“The stock market is a device for transferring money from the impatient to the patient.”

As always, please do leave us comments for us to improve on our articles.

As Singapore Value Investors Keep CALM and Be Financially Free

Leave a comment

Your email address will not be published. Required fields are marked *