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Choosing Stocks and Shares for Beginners

By Edited May 6, 2014 0 0

If you are researching buying stocks and shares for beginners, you are likely interested in maximizing your risk-adjusted returns.  The research in this field is inconclusive, however.  One of the legends of finance, Burton Malkiel, has written multiple best-selling editions of A Random Walk Down Wall Street, which is essential reading material for any investor.  He argues that asset prices are essentially random, so any "smart" stock pick you have won't have any effect, since the price movement will be unpredictable.  Some of his most cited evidence in the book shows that the most successful mutual funds in one period tend to not be winners in the next, indicating that skill does not play a role in the winning periods; pure statistical wandering from the mean is at play.

Fortunately, not all the research agrees with Random Walk Theory.  An example of one academic paper is Can Individual Investors Beat the Market by Joshua D. Coval of Harvard Business School, David A. Hirshleifer of Ohio State University, and Tyler Shumway from the University of Michigan at Ann Arbor.  Breaking their sample of investors into 10 groups, they found the top decile beat the bottom decile about 8% per year.  In an ensuing period, purchasing long positions in top investors' stocks and short positions in bottom investors' stocks produced abnormal returns.  They write, "Our results suggest that skillful individual investors exploit market inefficiencies to earn abnormal profits..."

Studies of Beating the Stock Market 

Tweedy, Browne has published a research paper What Has Worked in Investing that outlines the most famous historical methods.  This is a simply outstanding resource when researching trading stocks and shares for beginners.

Value Stocks

The first is value investing (attempting to buy undervalued stocks that are trading more cheaply than you think they should).  Breaking stocks into ten groups by the metrics price/earnings, price/book, and price/cash flow all show the same phenomenon throughout history: the overvalued stocks with the highest ratios do poorly, and the undervalued stocks with lower ratios produce higher returns.  These are excellent to invest in, as they have some of the most robust research showing their decades of great returns.  Since the research is so well established, this is one of the best stock market tips for beginners.

High Dividend Yields

The second method is purchasing stocks with high dividend yields, which you calculate as annual dividends per share/price per share.  Using the same methods, researchers broke stocks into 10 groups. The groups with the highest dividend yields outperformed all the stocks below them.  These are also some of the best stocks to invest in due to the strong supporting studies in their favor.

Small Market Capitalizations

The third method is purchasing firms of companies with small market capitalizations. Using the familiar method of breaking stocks into 10 sections, the researchers found that smaller firms' stocks produced better returns than those of larger stocks.  If you are learning how to invest in penny stocks, the research supports this method, and VISVX by Vangaurd (the Vanguard Small Cap Value Fund) is an outstanding option.  This is an incredibly simple, proven method of investing for beginners or market experts.

Recent Insider Purchases

A fourth finding outlines insider purchases.  Companies showing abnormal increases in insider purchases of a stock tended to have excess returns in following periods. This makes intuitive sense, as those working for a company would have better knowledge than the public of the company's prospects.

Stocks With Recent Price Declines

A fifth finding, which I give less credence to, is the buying shares with recent price declines. Tweedy, Browne cites studies that these also produce excess returns.  I am less supportive of this method, however, since robust studies exist showing that technical analysis such as this is generally ineffective.

Final Thoughts

Researching how to invest in the stock market for beginners can seem overly complicated.  However, sticking with low expense ratio funds and discount brokerages such as Options House using the above principles will set you well in your way to maximizing your stock market returns.



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