When you buy a share, you’re purchasing a stake in a living, breathing business. Buy shares of your favourite electrical store and you own the place. Literally. Every time someone picks up a new iPhone or DVD, a tiny bit of cash drops to your company’s bottom line. High five, shareholder!
Finding great share ideas is as simple as opening your eyes. Your fridge, medicine cabinet, wallet, computer: all hotbeds of investment ideas. Behind virtually every successful product or service lies a publicly traded company that’s cashing in on that success — and that you can join as a business partner.
Better know a better business
But a great service or product does not a great investment make — just ask anyone who invested in One-Tel during the dot-com era. Again, think of buying shares of a company just like buying a stake in a local small business. Does the business have staying power? How much cash flows in and out? Do you trust the management and employees to do right by you as an outside investor? Hardly questions you’d need a Harvard MBA to spell out for you, right?
Fools take the same commonsense approach to investing. We’re interested in the strength of a business. Not past performance, charts, or whether the shares trade at 10 cents or $50.
Specifically, here are a few things we look for:
1. A sustainable competitive advantage: Some businesses have unique, lasting competitive advantages that allow them to earn outsized profits. The more durable a company’s competitive advantage, the larger the “moat” that surrounds its financial fortress. Think about Woolworths’ and BHP’s pure scale, Seek and Wotif’s network effects, and CSL’s intellectual property. They are all classic examples of sustainable competitive advantages.
2. Cash aplenty: Cash is the lifeblood of any business. It pays the bills and covers the tab for new growth projects. Fools look for low-debt, cash-rich balance sheets and steady cash flows. Specifically, free cash flow — the cash left over after funding operations and growth — fuels share repurchases and those sweet, sweet dividends that show up in your bank account every six months.
3. Strong leadership: Is management invested alongside you? Do they have a history of creating value for shareholders? Do they have years and years of relevant experience? Do they treat outside shareholders (business partners) with respect?
If you stumble across a company that nails all of the above, odds are good that you’re looking at a great candidate for your hard-earned cash.
If you need help in finding such great companies, luckily you’re in the right place. Here at The Motley Fool, in our free regular emails, our special free reports, and our premium research newsletters (coming soon!), we aim to highlight the very best companies trading on the Australian share market. Click here to receive, for free, the best of our content sent directly to your in-box.
Now You’re Ready To Buy Your First Shares
You’ve paid off your credit cards. You’ve saved up an emergency fund. You’ve opened an online brokerage account. You’ve done your research and found the company of your dreams. Let the guns blaze!
Whoa there, tiger!
We’re just as excited as you are that you’re ready to be a shares owner. But before you go knocking on Mr. Market’s door, bearing cash and gusto, let’s keep some perspective.
First, this is just one of many investments you’ll end up owning. That’s to say, you want to invest in sips, not gulps. Your first purchase should be as petite in size as it is bold in spirit. Second, don’t forget that your first investment is also a learning experience. As any craftsman will tell you, there’s no better way to learn than by doing.
A journey of a thousand miles begins with a single step. And that’s what we recommend to you: Buy $500 worth of your favourite company. Just one company. This one share will teach you more about life as an investor than we could ever hope to teach you here. Follow it. Get to know it. Read the news earnings releases, look at the company’s presentations, and see how the share’s daily fluctuations affect you. For future purchases, you should keep trading costs and commissions to less than 2% of your total purchase amount, but we’ll let that slide on your first buy.
But there’s something else we want you to pick up while you’re making a stop at your friendly stockbroker: A stake in an index tracking ETF – those wonderfully efficient investment products we introduced to you in step 7.
Index tracking funds don’t look to beat the market — they look to match it as closely as possible. That might not sound enticing at first blush, but consider that index funds offer:
1. Instant diversification: When you invest in an index fund, in one fell swoop you’ve spread your dollars across industries, markets, currencies, and countries, substantially lowering your risk in the process.
2. Low costs: Index funds have much lower expenses than actively managed funds. The average actively managed US fund charges its investors 1.4% for the privilege of owning shares. Vanguard Australian Shares Index ETF (VAS), meanwhile, carries an annual fee of just 0.27%.
3. Superior returns: Over in the US, according to the Fool’s own research, only 42% of actively managed funds beat the S&P 500 through the 15 years ending January 2009. And we’re not alone; numerous studies both in the US and here in Australia show that you’re likely to underperform the index by investing in a typical “industry” fund. And as we just pointed out, you’ll pay a lot more for that privilege.
Little wonder that we think index funds should be the foundation of your portfolio. But for now, we simply recommend that for every dollar you put into individual shares, you roll the same amount into an index tracking fund (the Vanguard ETF we mentioned above is good choice).
But about that one share
Yes, we Fools love index funds, but we also believe everyone should own at least one share (and ultimately, at least 15 to reduce your risk and increase your odds for success). Why? Well, it’s fun (really!). By owning a share, you have your own little piece of history, and you get to witness firsthand the power of capitalism and entrepreneurship at work.
But just as important, if you want to beat the market, you simply can’t do that by investing only in index funds. In fact, your goal for every share you buy should be to outperform the index. So get out there and start having some fun on your way to market-beating returns.