Getting started in the stock market can be daunting. But for a lot of people, it can be a huge financial opportunity.
Over the long term, stocks and shares tend to generate better returns than cash and bonds. And this isn’t an accident.
What if share prices crash?
For a number of people, the main obstacle to investing in the stock market is the same. What happens if it crashes?
Share prices can fall sharply and – realistically – nobody can tell when this is going to happen. But this doesn’t have to be a problem.
The best investors don’t make decisions based on share price movements. They focus on businesses and their future prospects.
Stocks can fall 20% or more in a market crash. But it’s rare that companies suddenly become 20% worse in a week or a month.
Fundamentally, a stock is an ownership stake in a business. And this is what investors need to focus on, not whatever’s going on with share prices.
Finding companies with strong prospects is the key to investing well. But if there’s a chance to buy shares at low prices, that’s a bonus.
What makes a good investment?
The key to finding a good investment is finding a good business. This is one that has the ability to turn money into a lot more money.
A good example is Diageo (LSE:DGE). The firm has £9.25bn in things like manufacturing facilities and equipment and it makes £4.3bn in operating income.
That’s a 46.5% annual return. Outside the stock market, I can’t think of any ventures that are able to do this.
Diageo has a couple of unique assets that allow it to do this. One is its brand portfolio and the other is the scale of its distribution.
Those are either difficult or impossible to replicate. But the stock market gives investors the chance to benefit from the firm’s strengths.
Investing, however, is about looking past the current situation. It’s about trying to figure out what the company will make in future years.
Looking ahead
Diageo made around 80p per share (it reports in dollars) last year and has a share price of £14.65. That implies a 5.46% return at today’s prices.
That’s not bad, but the question is whether it’s going to go up, down, or nowhere. Figuring this out is what investing in stocks is all about.
The falling share price suggests investors are becoming more pessimistic. And there are real signs that people are drinking less.
A falling share price, however, isn’t always a warning sign. Investors might be underestimating Diageo’s strength and the opportunities ahead.
The firm is looking to sell off some of its more peripheral assets. And it’s aiming to appeal to more price-conscious consumers. Whether or not it will work remains to be seen. But I think this is a stock that investors starting out might want to take a look at.
How to start investing
The key to investing in the stock market is understanding the difference between a company and its share price. Everything else follows from this.
What to buy and how to cope with a crash come down to following businesses over share prices. Ultimately, that’s how to be a good investor.
