Growing up I was always told that shares were “too risky”. My parents were big fans of traditional bricks and mortar.
However, now I realise that there are very few people who have created exceptional amounts of wealth through traditional home ownership. By comparison, share ownership has created more than just one billionaire.
When you look at the Forbes Billionaires list there seems to be three key ways to create wealth. You can:
I don’t have much chance of inheriting wealth. And I have no interest in running a business. But one thing I can do is invest in shares, which gives me a slice of a business.
The sharemarket is an exciting place to make money. Unfortunately, it can also be an easy place to lose money. To separate the winners from the losers, there are some simple rules that can be followed to help improve the chances of success.
At the end of the day, a share isn’t simply a price moving up and down. Behind the share is an actual business, and a successful business will see its share price rise on the back of anticipated profits.
Take for example the following two companies:
Both companies are retailers, yet they have seen very different performances in their share prices.
In 2009, David Jones’ share price increased by 70%. During that same period, JB Hi-Fi increased by almost double, with an increase of 130%. So why the difference in performance? It’s important to understand the underlying business.
JB Hi-Fi is predicted to grow its profit by 24% in over the next two years. Compare that with David Jones which is only forecast to grow by 6%. Since JB Hi-Fi is growing its company faster, investors are willing to pay more money for the future growth.
So you’ve found a business that is increasing in profit. What else should you look out for?
Like anything that you want to make a profit on, the key is to buy low and sell high. Easier said than done. How can you find something that is trading low?
Buying low means buying at a cheap price into a share that is likely to attract buying activity. I like to use a valuation ratio such as a P/E ratio. It simply gives me an idea of whether I am paying a premium for the share. I don’t mind paying a premium as long as I am confident of greater returns in the future.
Brokers will give you an intrinsic price that they think the company is worth. They will then base buy/sell/hold recommendations based on what they think the company and business is worth.
Technical analysis also helps to gauge sentiment in the market. At the end of the day, the sharemarket is buyers and sellers agreeing on prices. The charts can help with timing both your entry and exit points.
In the end, the sharemarket provides lots of opportunities. While the headlines say that the market is going down, there is usually a company that will benefit. So look beyond the share price, look beyond the hot tips and look to the underlying business.
After all, while the sharemarket can be an illogical place, making profits by investing in businesses can be a very logical one.
Happy trading!
Julia Lee Equities Analyst Bell Direct Have you started trading with Bell Direct for just $15 a trade? Register now for free.