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Six Tips For Starting With Shares

By Maynard Paton (TMFMayn)
May 16, 2002

"How should I get started with shares?" It's a frequent question on the Motley Fool discussion boards. As I manage one of the Fool's online share portfolios, I'd thought I'd take an opportunity to distil my six top tips on getting started on the stock market.

1) Consider an index tracker

As regular readers of the Fool's portfolios will be aware:

Consistently beating the stock market over the long-term can be very difficult.

So, first off, consider a low cost Index Tracker. If we use history as our guide, then over the long-term, an index tracker will outperform all other forms of investment, the majority of managed funds and (quite probably) most other private investors too. Best of all, the tracker requires no time, skill or worrying over long-term underperformance. On an effort to reward basis, the index tracker certainly outshines all other alternatives hands down.

2) Be patient

If you must begin trying your hand at stock picking, then I'd advise:

"Don't rush!"

Regardless of whether the stock market is racing ahead, or that first share you've got your eye on has just risen 30%, patience is undoubtedly a key stock picking virtue.

You see, the stock market will still be around next year and the year after that. And it always has a habit of throwing up good investment opportunities every once in a while. For instance, judging by the performance of the FTSE 100, those investors starting out three years ago are currently seeing similar share prices as they did back in 1998.

So be patient. There's a lot of homework to be done first! You wouldn't fork out thousands of pounds and build your own conservatory just using your intuition, would you? Yet many novices spend similar amounts of money buying shares on a whim. Needless to say, there's no quicker route to portfolio heartache than "gut feel".

3) Form a strategy

The basis of your investment homework concerns forming an investment strategy. Having an overall investment strategy leads to clearer thinking and reduces the stock market distractions. The best way to form an investment strategy is to start off by using somebody else's. Indeed, the Qualiport's own philosophy is largely based on Warren Buffett's.

Pretty much the easiest way of getting up to speed with proven, successful investors is to buy their books. They won't tell you everything, and they all have their own individual technique to tell, but the authors listed in this feature all provide sound Foolish guidance.

Also consider your personal circumstances. For example, most people don't have the time to constantly keep an eye on their portfolio during the week. If this is the case, obviously the stock picking strategies that involve longer term holding periods should be sought.

4) Remember valuation

It's a common mistake. You find a great company whose products or services should do well in the future, but forget about valuation. So get this:

Great companies don't always make great investments.

A company's valuation is based upon the expectation of the company's future profits. As the TMT bubble painfully highlighted, pay too high a price for those future profits (especially when those future profits fail to materialise) and your shares will suffer. It happens even when investing in the best of companies. Anybody who bought Microsoft (Nasdaq: MSFT) stock around Christmas 1999 will now be sitting on a thumping 50% loss.

Company valuation can be a tricky business. Everyone has their own way judging a share's "fair value". But whenever you buy a share, always have an explanation as to why it's undervalued at your buy price.

Oh, and stamp these three words on your forehead, too:

"Margin Of Safety"

In other words, ensure there's some room for error in your valuation calculations before you invest.

5) Understand accounting

In order to discover how much profit a company is generating, and therefore, make a judgment on the company's valuation, you need to get to grips with accounting. Unfortunately, understanding those funny numbers at the back of an annual report is pretty much a must-do for any serious share picker.

The Motley Fool's UK Investment Work book is a good starting point. If you don't know the difference between FRS3 earnings per share and normalised earnings per share, or between creditors and debtors, or between return on sales and return on equity, then you're going to struggle on the stock market.

What's more, accounts can also highlight whether companies are heading for trouble. Working capital difficulties, excessive debt and regular exceptional items can all herald imminent share price turmoil. Ignore the numbers at your peril.

6) Nothing beats personal experience

Never rely on anybody for share advice. Whether it's some City analyst or your Sunday broadsheet, nobody ever got rich by following stock market professionals.

To make money from investing, you have to do all the hard work yourself. You have to independently find you own way around the stock market and discover undervalued companies on your own. In the early days, expect to make plenty of mistakes. And beware. It takes a some time and effort before you develop the experience and your own personal investment strategy to consistently pick stock market winners.

More: Full details on how to start building your share portfolio

This article was orginally published in October 2001