How to Actually Make Money From Stocks

How to Not Invest Like a Dummy

An old college professor once said to me, “You have a better chance of making money gambling in Vegas than you do in the stock market.” He had recently returned from a “business” conference in Nevada and was chatting to our International Finance class about the experience. He is also an Investment Banker. 

 

Participating in the stock market is an activity that, like gambling, is different from person to person. Depending on your tolerance for risk, each person is going to have an entirely unique experience. Buying and selling stock can be as dangerous as you make it. The amount of risk you take is entirely up to you! 

 

Investing your money into stocks, especially when you’re young, can put you in a very comfortable financial position for the future. Making moderate investments now can materialize into substantial payoff 10-20 years down the line. 

That being said, my professor was right to compare the stock market to poker. The reason ordinary people tend to lose out in the stock market is because most people use stock price as an indication of a company's “worth”. Generally, people look at how a company's stock price has fluctuated within the past 5-years and use that alone to decide whether or not it’s a wise investment.

 

This, frankly, is complete and utter cr*p. 

 

A company's stock price is not to be trusted and WILL NOT tell you if it’s a wise investment. If you use stock price to decide whether or not to buy into a company, you may as well use that money to book a ticket to Vegas instead. 

 

Instead, let me introduce you to 5 equations that will really tell you whether or not the “gettin’s good”. The 5 methods listed below use a company's balance sheet to give you a FAR MORE accurate idea of whether or not a company is likely to make you money.

 

For those of you with no background in accounting or finance, these methods have been simplified to show you → how to get the number you want to evaluate → what that number says about the company. 

 

(To find the terms used below such as Net Income, Google the company name followed by “balance sheet”)

 

Without further adieu, here are the 5 numbers you need to know whether or not a company is ripe for investing. 

 

Financial Ratios to Assess a Company’s Profitability 

1. Working Capital 

  • Current assets / current liabilities = liquidity → how well a company can turn assets into cash to pay off short-term obligations (debt)

  • Want a large ratio like 2:1

2. Earning per Share

  • Net income / average # of common shares = about how much each stockholder earns per share of company stock that they own

3. Debt-Equity Ratio

  • [Long term + short term debt] / shareholder (owner) equity = rate of borrowing

  • Want a smaller number closer to 0

4. Return on Equity

  • [Net earnings after taxes - dividends] / common equity = return on investment (how much shareholders are making on their initial investments)

5. Profit Margin

  • Net income / revenue = profit margin → how profitable a company is 

  • Want a higher number (if profit margin = 1 then company is converting all revenue into net income)

  • Pattern of decreasing profit margins is BAD

That's all for now, folks. I bid you happy, and wise, investing!