The most frequently asked question by potential stock market investors is "what is the best stock to buy". This article is aimed at demystifying the stock market and providing a foundation for investment knowledge for those who are new to the stock market.
Knowing your objectives for the future is the starting point in determining the type of investment you make today. Investing in shares can be one of the most flexible, lucrative and rewarding forms of investment there is.
A share is a piece of ownership of a company or enterprise. When you buy a share, you become an investor and thereby an owner of a piece of the company's profits or loss. By and large, it is companies that create wealth in the global economy. But, in order to generate that wealth and take advantage of new opportunities, companies require funding. Some companies choose to borrow and pay interest on loans. Others give up a degree of ownership in the company and issue shares (or equity). Those companies that choose to offer their shares to the public are known as public companies and these shares are bought and sold on various stock exchanges throughout the world.
The two types of return on an investment expected by shareholders are:
- Capital Gains
- Dividends
Capital gain is a gain on the initial sum invested as the price increases. If for instance, Uchumi Supermarkets Ltd moved from KShs 10.00 to KShs 16.00, the capital gained by the investor would be KShs 6.00.
Dividends are like a small reward companies pay shareholders for owning shares of its stock. The company generally takes a portion of its earnings, which it divides and distributes to shareholders. In general, a company that has a slow growth rate (few investment opportunities) pays high dividends. On the other hand, a company with a high growth rate usually pays no dividends all as their profits are reinvested to help sustain higher-than-average growth.
Every purchase involves a degree of risk. There is the risk that relates to the market as a whole - for example, if interest rates rose, or if political instability increased, companies across all sectors would be affected. There's not much an investor can do to counter this kind of risk. There is also the risk that relates to a specific stock. An example of this unique risk would be if for instance you have invested in Oil and Gas Petroleum company, and they're waiting for some important results from digging an oil well based on some scientific exploration that had been carried out. The wells they dig may have oil or may be unsuccessful. Petroleum exploration is very costly, deals with many unknowns, with high risk and uncertainty. The risks of holding that particular share to the exclusion of all others would be large. The way to minimize this unique or stand alone risk would be through diversification.
Several general factors cause movements in share prices. These factors are:
- The general view of the economy as a whole
- The conditions related specifically to the company's particular industry sector and
- The performance of the company itself.
How these factors are viewed is rather subjective, one's decision to buy or sell a company's share will be based on their view of its prospects relative to its market peers.
So what is the best stock to buy?
There are several qualities to look out for when purchasing shares:
- Company sells a good product/service that does not have close substitutes, have a competitive offering and one that has potential for continued growth.
- The company is managed productively, transparently and is accountable to shareholders.
- Competent Management team
- No wastage in the use of resources, and increased potential for growth in the future.
- Respect for the shareholders and their opinions
- Liquidity - (Shares should be easy to buy and sell quickly in the market with relatively low appreciation/depreciation in value)
- The company abides by the rules, regulations and laws set by the CMA and the Laws of the country within which they operate.
- Shares of company that has continued growth in earnings, stable or increasing profit margins and a strong balance sheet where the debt to equity ratio is not too high - the lower the debt the better.
- Consistent operating history.
Your decision to invest will be a lot easier if you inform yourself.
The fundamentals of investing in equities are simple. Once these are grasped, the level of knowledge you can acquire is virtually limitless. There is a huge amount of literature on the subject of investment.
To make the most of your investment, we advise that you monitor the activities of the NSE on daily basis. We encourage investors to read business pages of the daily newspapers, business magazines and write-ups in the electronic and print media and leading financial journals and to be in regular consultations with financial advisors on regular basis.
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