How to successfully play the stockmarket

Published by Steve McDowell on 18 April 2011.
Last updated on 19 May 2011

Investment key

If you think you're not already exposed to the world of investing, think again. If you have an individual savings account, certain types of mortgage or a pension, the chances are you have already experienced the volatility of stockmarkets without even realising it.

So why not have a go at directly investing in shares yourself?

The easiest way to access the stockmarket is to buy a fund, which is a basket of shares picked for you by an expert manager. However, a manager will charge you for this service, sometimes quite a lot. So if you're brave enough, there's no reason why you can't start buying and selling shares yourself - and do so successfully.

Read: What's the best way to buy a fund?

Getting started

But before you start let's get one myth out of the way: you don't need to have a lot of money. Share ownership is not the preserve of the elite in the City of London. Shares in public companies can be owned by anyone in the UK over the age of 18. How much you invest is up to you, but like all ventures that carry risk you should not invest what you cannot afford to lose.

Having said that, you'll want to put in as much as you can to maximise your gains – given you'll be charged for every trade you make. A good guideline on how much to allocate would be about £1,000 in order to minimise the impact of the trading cost and the 0.5% stamp duty.

Share investing should be for at least five years, give or take. Anything less than that means your money hasn't got enough time to grow, so, again, it's important not to invest money you can't do without over that timescale. You can access it if you need it of course, simply by selling the shares, but it's important to remember you're not speculating or gambling, you're investing.

So what is a share? Put simply, a company is divided up into parts. If it's worth £100 million and there are 50 million shares in the market, the price of that share is 200p. That price fluctuates according to the value of the company and how many shares there are in the market.

However, it's not quite that simple because you have to throw in a nasty little thing called 'sentiment' too. This means the market itself may not like the sector in which the company operates or its management and, as a general rule, shares rise on the expectation of, rather than the actual, results.

If a company's results come out and they show profits are up 50%, the share price may well fall because results better than that were already predicted and 'priced into' the share.

If the company does well, however, it will pay a dividend to its shareholders – a cash sum that's like a loyalty bonus for being a shareholder.

So a share price is like a barometer for the investors' confidence in the company.

Do your homework first

The next step is to do some research. Peter Lynch, an ex-Fidelity legend of investing, once said: "Investing without research is like playing stud poker without ever looking at the cards.f"

You also need to choose your investment strategy. It might be best when starting out to pick a sector you're familiar with. The industry in which you work, for example, or a favourite retailer. Perhaps you notice your local Sainsbury's is always full of people and the tills are rattling but Tesco is not so busy. So if you like the look of Sainsbury's rather than Tesco, you can start to do a bit of analysis into its numbers to back up your observations.

In Cityspeak this is called a 'top-down' approach. The other way around – a 'bottom-up' approach – would be to start with the numbers: the company's annual report and accounts, for example, and its data in the share pages of a newspaper. Look out for key indicators which show you whether or not there's value in the share. You then end up looking at the share price and the business as a whole.

Watch out for key indicators

The price/earnings (P/E) ratio is the best known indicator of whether a share is cheap or dear. It's a measure of a price paid for a share relative to its earnings.

Richard Beddard, companies and markets editor of Interactive Investor, says: "Earnings are the net profit remaining for the owners (shareholders) of a business after it's paid all its bills. Crudely, the lower the price an investor pays for a share of the profit, the better the deal. So low P/Es are good, but there is a complication: it's the company's future profits that matter, and they're usually very difficult to predict. You can assume profits will be similar to previous years, use the best guesses of City analysts, or attempt your own forecasts. The latter is definitely not for beginners."

Take the example of Sainsbury's: we can see in its year-end 2010 report that the company's earnings after tax were £585 million and its market cap was £6,252.71 million. This gives a P/E ratio of 10.45. In general, a healthy company will have a PER of 15 to 25. If it's above that, it's probably overvalued. But if you're looking for bargains, you want under 15.

You also need to consider the dividend yield – that's the dividend amount divided by the current stock price. The higher the better, but typically a yield in the range of 4% to 6% would be considered quite good. Sainsbury's is 4.24%.

Next, look at earnings per share. EPS is calculated by dividing total profit by the number of shares in issue. (Sainsbury's is 32.1.) This is a good way of calculating the potential value of a share against its price, though essentially it's just a comparison of profit to the number of shares in issue. Anything with a positive earning per share is good news.

The next step is to open an account. A broker will charge a fee for executing your deals, so going online is best; it's cheaper, you can keep track of your shares wherever you are, and all the paperwork you need – share certificates and tax documents – is in one place.

And once you've made sure your portfolio is as diversified as possible, by picking at least 10 shares from different industries and sectors, you will have all you need to begin – so good luck and happy hunting.

Read: 10 golden rules of buying shares

The golden rules of research

Is the company…

• In a sector you know well?
• Making/doing something unique?
• In possession of a good track record?
• Growing? What does its year-on-year performance say?
• In possession of a cash pile?
• In profit? If not, are the revenues going up every year?
• Considered to be high-risk/high-growth or steadily growing?

Does it…

• Pay a dividend?
• Have a lot of debt?
• Show a share price that goes up and down wildly?
• Have good reviews from analysts?
• Have a competitive share value? What is its price/earnings ratio or (P/E)

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