Like most stock investing-focused websites, PHStocks has to have some sort of basic information regarding investing in the stock market. Also, I keep receiving messages from people who feel they are now ready to start to invest in stocks, but are quite unsure how to proceed.
Therefore, this particular post will be the first part of a series of posts that will provide more information on what investing in the stock market is, why one should invest, and how one can invest in stocks.
(PLEASE NOTE: This article series is intended for those who ARE VERY NEW OR HAVE NO IDEA on what stock investing is.)
So first, what are stocks? Quite simply, stocks are shares of ownership in a corporation. As long as the company is publicly listed, you can buy stocks of that company and become a shareholder of it. Of course, as a part owner of a company, you will participate in that company’s growth and future profits. On the other hand, and most importantly, you may also lose if the company suffers a loss or performs below market expectations.
Now, stocks of these companies, for example Metropolitan Bank & Trust Co. (PSE: MBT), Petron Corp. (PSE: PCOR), Vista Land & Lifescapes Inc. (PSE: VLL), Rizal Commercial Banking Corp. (PSE: RCB), Vulcan Industrial & Mining (PSE: VUL), and EEI Corp. (PSE: EEI), to name but a few of the listed companies in the Philippine Stock Exchange (PSE), can only be bought–and sold–in the stock market, through a registered stockbroker. I will provide a list of stockbrokers later as we go along.
Why Invest in the Stock Market?
Over the long term, stocks provide potentially higher returns and protection against inflation. Therefore investing in the stock market is one of the best ways to grow your wealth and reach your long-term financial goals.
But first, why is inflation always mentioned when we talk about stock investing? Quite simply, inflation is the general increase in prices of goods and fall in the purchasing power of money.
Let’s make a very basic example. For instance, let’s say a hamburger meal today would cost PhP100.00. Given the Philippine government’s inflation target range of 4% ±1 percentage point for 2014, that same hamburger could potentially cost PhP104.00 next year.
Now, you saved PhP1,000.00 in a bank so that you could buy 10 hamburgers next year for your birthday. Given that 4% inflation, the total cost of those 10 hamburgers would already be around PhP1,040.00! At best, you could only buy nine hamburgers instead of the initial 10 you are planning. See the effect of inflation? The price of goods increased, therefore the value of your money decreased.
BUT, you will say, your money should have grown through interest in the bank! Of course it will. But let’s see, the average interest rate in Philippine banks is around 1.375% per year. So that PhP1,000.00 you deposited will just amount to PhP1,001.375 by the time you are planning to buy that hamburger–leading you to buy just nine pieces.
Therefore, investments are made to generate future purchasing power that will keep ahead of inflation and provide investors a sense of financial security. You can achieve your financial goals for your different financial needs over different time horizons like buying a house, paying for your child’s college education, and setting aside for your own payment.
Of course, you need to do a lot of homework, but definitely, and this you will find along your investing journey, the rewards are big.
How do we gain money, or build wealth, from stock investing?
There are two ways: one is when the stock price of the company you have invested in has increased–this is called capital appreciation; and second, if the company will give dividends out of its earnings to investors.
1. Capital appreciation is an increase in the market price market price of your stock. It is the difference between the amount you paid when buying shares and the current market price of the stock. However, if the company doesn’t perform as expected, the stock’s price may go down below your purchase price.
For example, if you buy a share of stock at PhP100.00, and it rises to PhP110.00, your capital appreciation or gain is PhP10.00. Keep in mind, though, that you can only realize your gain of PhP10.00 if you sell at PhP110.00. If you chose to hold it and it further increases to PhP150.00, your capital gain would be PhP50.00. However, if your stock decreases to PhP100.00 then you sell it at that price, your capital gain is zero.
2. Through dividends declared by the company
Dividends are paid out to shareholders, representing earnings of the company that is not going to be reinvested in their business. In general, there are two types of dividends that can be given by companies: cash and stock dividends.
a. Cash dividend is the earnings for every share of stock declared by the company. So, if the company declares a dividend of 25 centavos (PhP0.25) per share, a stockholder with 10,000 shares will receive a cash dividend of PhP2,500.00, gross of tax (PhP0.25 x 10,000) in cash.
b. Stock dividends are additional shares given to shareholders at no cost. If the company declares a 25% stock dividend, a stockholder with 10,000 shares will be entitled to an additional 2,500 shares of stocks. These shares can also be sold anytime after the shares have been issued.
The power of compounding
Albert Enstein once said: “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t, pays it.”
Basically, compound interest arises when interest is added to the principal of a deposit or loan, so that, from that moment on, the interest that has been added also earns interest. It means you begin to earn interest income on your interest income (your money gained a certain value, and then you use that value to reinvest, giving you a bigger principal that would potentially give you a bigger interest gain), resulting in your money growing at an ever-accelerating rate.
Let’s say you saved a portion (PhP10,000.00)of your 13th month pay at the start of this year. Below is a screenshot from Sun Life Financial Inc. (PSE: SLF) to illustrate the power of compounding given an initial principal of PhP10,000.00, and different interest rates. The minimum interest rate shown here is 2%. There may be a bank who’s offering that, I am just not sure who, and also, if PhP10,000 is indeed the minimum principal amount needed to have that special discount. Otherwise, we’d consider the 1.375% rate I mentioned above.
From the above figure, your PhP10,000 will earn an interest of PhP200 at the end of year one. This (PhP10,200.00) will then become the new principal that will earn 2% at the end of year two. And so on, and so forth.
Here’s the thing, however. I mentioned earlier the effect of inflation, right? So basically, from the above rates, the 2% and 5% columns are not that “attractive”, compared to the 8%, 10%, and most especially the 20% columns– decent gains that can only be achieved in stock investing.
Take note, that is just from the PhP10,000 you initially deposited, or invested. If you will make investing in stocks a regular thing, maybe having a monthly pledge, I am pretty sure that your gains will eventually be higher.
So we’ve discussed what stocks are, why you need to start considering investing in stocks, and how you can make money from the stock market.
In the next post, we will discuss pitfalls to avoid, the market participants, and stock brokerages that you can choose from to start investing in the stock market.