5 things you must understand before buying individual stocks

I was recently approached by one of my friends asking my opinion on the individual stocks that he purchased. I couldn't express my opinion clearly then and it inspired me to write this article.

The problem is that even many of finance students who studied financial theories don’t understand the fundamentals of stock investment well. It didn’t click me until recently either. Putting the complicated ideas (time value of money, WACC, financial modeling, etc.) aside, I think people need to understand the following, as bare minimum before investing in individual stock, in order to be successful.

(1) What are stocks?

First, you must have some idea of what you are buying before paying for it.

To grasp the basic idea, you can watch this video. It’s short, concise and it’s easy to understand.

If you want to know a bit more detail, you can also refer to this Investopedia article.

https://www.investopedia.com/terms/s/shares.asp

You should also read an article about equity as well to understand the concept better.

https://www.investopedia.com/terms/e/equity.asp

(2) What is Market Cap?

When discussing stocks, everyone talks about market cap. It will be difficult to follow the news without understanding the market cap.

(3) What are Net Income (Profit, Earnings) and Earnings per Share?

Net income is a key indicator of the performance of a company. You need to understand what it is to understand the value of the business.

(4) What is Free Cash Flow?

In my opinion, this is the most important concept you need to understand. Many of finance students don’t understand the concept either. You need to look at net income in conjunction with the free cash flow.

(5) What are stock multiples?

Without understanding stock multiples, it’ll be difficult for you to identify whether a stock is “cheap” or “expensive”.

In general, the lower the multiple is (P/E, P/FCF, etc.), the cheaper the stock is.

I like using P/FCF the most, which is not as conventional as P/E so there isn’t much video explaining the concept…

After reading the articles and the videos posted here, I believe you will be more informed and gain at lease a bare minimum knowledge you should have to start buying stocks. I hope you will keep learning in a way that they can find value stocks and consistently beat the market.

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