How to pick a stock: Best practices from industry experts
By Winnie Makena | June 23rd 2021
No quote has ever been more apt about getting your hands dirty with investments like Warren Buffet’s ‘Be fearful when others are greedy, and greedy when others are fearful.’ Few people know exactly where the money is in stocks. This is why Enterprise speaks to two industry experts who share their insights on what one needs to know when dipping their toes in the stock market. John Yuaya is a full time trader in the stock market for two years now, and Johnson Nderi is the manager of corporate finance and advisory at ABC Capital Limited.
But first, the basics...
What is the stock market?
Investing in stocks simply means buying tiny shares of ownership in a public company. Those small shares are known as the company’s stock, and by investing in it, you’re hoping the company grows and performs well over time. And as a partial owner in the company, its success is also yours. Operating much like an auction house, the stock market enables buyers and sellers to negotiate prices and make trades. They do this on the stock market like the Nairobi Stock Exchange.
To better understand how to invest in stocks it is important to debunk the misconceptions.
Stock trading is not gambling
Key difference is when you gamble ShX you may gain more or you may lose all of ShX. With stock trading, if you put in ShX, you may gain more but you may lose ShY. Note that it is highly unlikely you will lose your entire investment in one day.
If the economy is underperforming, is the stock market too?
This is another common myth. Stock prices usually factor in what investors think will happen in the future. Hence share markets usually rise during a recession as investors are looking into the future and believe there will be a recovery in the economy.
“You can trade the stock market through derivatives or through a cash market,” says Yuaya, adding “a derivatives market is a speculative market where you can buy short stocks plus you get leverage from your broker hence you can invest with as little as Sh2,000.”
Short selling is where an investor makes money when a company’s share price goes down.
Remember when Gamestop, through the collective effort of Reddit users shot up to $300 per share from $4 for the first time by short selling? How short selling works is an investor pinpoints a poor-performing stock with the assumption the price is going to drop. That investor borrows shares of the stock, typically through a broker, then sells the stock and waits for the price to drop. Once it drops, the investor can then buy the stock back and return it to the original seller at a profit.
“Now if you decide to trade the derivatives you may not be able to get dividends, you should confirm with your broker on such information.”
Cash market essentially is when you own the stock which doesn’t really have a fixed price. When you want to liquidate it, you will have to find the best price on the market but you will have all the advantages we decided above on voting rights. If you ask me most investors will trade on the cash markets but traders deal with derivatives,” explains Yuaya.
How does one go about choosing the right investment?
Before diving headfirst, do your homework. There are a few things you can check about the company.
1. Look at the top management. Is their history/track record reassuring? Did they leave their former work places flourishing? Because history often repeats itself.
2. What is the product they deal in? Is it something that is always in demand?
If the recent fallout of investors with Cytonns’ fund has taught us anything, it is that putting all your faith in a particular company based on their publicity or assumed good performance can cost you your investment. Do your research, reviewing a stock’s fundamentals to monitor its viability and check if it still has room in your portfolio. Nderi reckons that to choose the right investment, you need to ask three questions.
1. What is the desired investment horizon?
2. What is your risk appetite?
3. What is the required rate of return?
Choosing the right broker
If you would like to choose stocks and stock funds on your own you can and it is easier than you think. The best choice for Nderi, however, is letting an expert manage the process for you.
“Personal finance professionals are the first people you consult to develop a financial plan,” he adds.
Getting a good broker is the first step:
1. According to Yuaya, it is beneficial to find a forex trader regulated by the Capital Markets Authority (CMA) of Kenya. “The two top brokers in Kenya are FX pesa for a minimum deposit of $5 and Scope markets for a minimum deposit amount of Sh2,000.”
2. Check on how they deliver the bare minimum. On choosing a broker as a beginner, Yuaya advises to consider how easy it is to communicate with them.” When you have queries, are they responded to quickly or do you have to call a hundred times to get a response?”
3. “Also look into how much commission the broker will charge you,” says Yuaya. You do not want to pay exorbitant rates.
4. How easy is it to withdraw and deposit your money? Speaking to someone who has worked with the broker helps.
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