How to Make 1000 pounds a profitable Investment in UK Stock Market - Essay Example

? Introduction: - Investment in stock exchange is a risky business. If a person has ?1000 and he has to invest that money in stock exchange to earn aprofit, he has to research the inclination of the market and select one maximum paying investment method. Now, five methods are listed below despite, being hundreds of other, which can be utilized to earn money in stock exchange with good results , but none of them is risk free. In this paper, pros and cons of all these five methods will be discussed and in the end the best method out of the all five and the worst of all five will be deduced based rational discussion. These five methods are: a. Buy stocks of the companies that have undervalued ratings. b. Acting on rumours knowing that it is in fact a rumour. c. Buying Dividends for long-term investment in stock market. It is a stable and less risky way of earning profit. d. Opening an account with a broker. e. Investing in Penny stock to earn profit. Method 1 Basic Plan: The first method is to look for companies that have undervalued ratings. This method does have it perks considering that undervalued firms have a lot of value, of which general public is unaware, due to rating agencies (Graham, 1985). Now the first scenario is an investor having ?1000 and he or she has to make money through investing it in stocks looking for undervalued companies. The first reasonable thing that the investor should do is to look into companies, which have the least value on the FTSE index. For example, the investor comes up with four companies, whose stock value is ?2, ?3, ?3.50 and 3.75. Initially, I will analyse why that particular company is undervalued, does that company have large debts that it needs to pay, or the company has a record of bad investments or if the company was indicted in law-suits involving fraud etc. If the company has large debts, the investor shall see the prospects of that company paying off the debt while pragmatically and logically calculating, the duration in which the company will be able to pay its debt. If the investor wants to earn the money quickly i.e., in a week and he or she is able to find a company that can pay off its debt in two weeks, it would be best to buy stock of that company. And if the prospects of paying debt are low, the investor shall not invest in that company because of the obvious downfall state of the company. One thing that shall be kept in mind that, one must not sell all the shares if there is a slight rise in stocks because of the thought about, being on the safe side. One must project a slight confidence by observing the attitude of the market towards that company if that attitude is confident towards it then there’s no need to sell the price and if the attitude contains lack of confidence, then one must sell shares at the price offered as earliest as possible, if one wants to liquidize stocks instantaneously. Another way is to invest it, in two or more companies at a time. The approach shall be the same as above and the reason to invest in two or more companies at a time; is unreliability in any one company. It’s just an alternative because companies are being kept undervalued for specific reasons. Sometimes the reason is right and justified in view of the person who wants to invest, but not always. This is a good way to earn money, but the chances of earning money quickly are very bleak. Drawbacks: The biggest risk involved in this kind of investment is, in case undervalued company gets further devalued because in such cases the value of stocks further decrease, resulting in loss for the shareholders. Another drawback of this plan is lack of experience of the investor who is investing the amount of ?1000, which is a high value. It is very important that a person should be an experienced investor person while investing because then there might be rational discussion taking place instead of decisions made on gut feeling. Another risk here is of fraud and being conned, which is very common for new investors. A new investor might get caught because of his or her unfamiliarity with stock exchange. The only way to avoid these types of attitudes from the market and people associated with market is to make sure that an investor knows when he’s being irrational and when it’s worth taking risk. Stock exchange is much more like gambling; sometimes the player (investor) wins and sometimes the investor losses. , but in gambling the biggest factor involved for success is luck while in stock exchange the biggest factor is rational decision making. If one wants to be successful in stock exchange, the investor must take decisions as if he owns the company and taking decisions like a manager who has the authority and liability, not as an adviser who has nothing to lose. Method 2 Basic Plan: Buy stock when rumours flow around. This plan is also very good, but one must be constantly present in the market for actually taking benefit from this plan. The approach that one has to take here is, constantly to be alert about the rumours that are flowing around the market. For example, when the BP oil was spilled near the Gulf of Maxico the fine imposed on it affected it shares and consequently they fell down. (Farrell, 2011). Now, let’s say another rumor enters the market that BP has experienced another oil spill near the Mexican gulf because of a hurricane that the crossed the Mexican gulf; within few minutes time BP’s shares will fall to the bottom because of the occurrence of same incident. And possibly in these times of recession BP might have to pay another fine, which will lead to decrease the confidence of BP’s shareholders. So what is the exact time, when one must dive in with regard to rumors? If an investor can judge that the rumour about BP’s oil spill is true, then he or she must wait till people start selling stocks and buy shares at the time, which according to Lloyd and Thompson is the lowest price rate time in a year (Lloyd & Thomson, 2011). Drawbacks: The probability of this method to work is very rare. The reason for which is the judgment criteria being, whether the information entering the market is true or false. In case the rumor turns out to be true, then the chance of recovering the invested money decreases substantially. Another drawback of this plan is again a decision being made on gut feeling. As mentioned for plan 1, to earn a profit from stock exchange, one must have coherent decision making skill and does not take decisions due to greed of profit or on instincts (Prade, DuBois, & Bouyssou, 2010). But sometimes rumors are true they foretell leads towards lawsuits, which results in low worth of stocks and ultimate crash in less time. This happened during the New York stock exchange crash of 1929, which triggered the great depression (Top of Form FIELD, 1984). Bottom of Form In the Current time of recession, one should be careful and be aware of all the rumors because currently the unreliability has increased due to change in economic, law and consumer taste; therefore, all the tumors need to be taken seriously but not acted upon instantly. The risk involved in this method is, the way the market will react to company’s investments. Very recently Facebook decided to do IPO (Initial Public offering), the market confidence was high and there was hype in the market that Facebook will do well in the market, but all this hype went from buzz to bust when Facebook on its first day of trading barely remained above its opening price and is now well below its original offering price. The result of which, is the founder of Facebook, Mark Zuckerberg now being sued by Facebook investors for showing an overvalued price of the company , which led people to believe the assumed price as a worth of the company and lost a lot money (Ian Wallis, 2012).  Method 3 Basic Plan: Another method from, which profit is considered easier, is to buy stocks that offer dividends. This method is also good considering that a company will pay its share of corporate profit to its customer. This method has no ethical strings attached to it and is the best rational way to earn money through stock exchange. Another good thing about dividends is that at any time of the year a company can announce special dividends i.e., an unexpected profit, which can be distributed among the shareholders. Special Dividend is different from dividend in general sense because it is variable and it changes over time as opposed dividend in general, which is fixed. This can lead to unexpected profit for the investor, which makes dividends an even better option for a person investing in stock exchange. Out of the ?1000, a person has to invest in a company; he or she shall not invest all of it in the one company because in this case a person the source of profit will be one. The same approach of method 1 shall be applied here so that there is more than one source of profit. If one company is unable to offer dividends then the other can and in this case loss and profit both can be neutralized, which in case of a single company will result in total loss of the company when decides not to pay dividends. Hurley JA had the following view about dividends, “In determining whether a dividend is payable out of profits…the approach makes the right of a shareholder to a dividend, which has been declared and managers, which is contrary to one of the fundamental understandings of company law”.(Cassidy, 2006) Even though point can be raised that if both companies are unable to earn profit then there is total loss; , but in a bigger scenario the probability is much less i.e., 1:2 , which is comparatively better as opposed to investing in a single company. According to S. H Wallick, there are five basic tips to identifying a good dividend company, a. Look for companies that have a history of paying dividends through good times and bad, including the most recent recession b. Search company financial reports, presentation transcripts, interviews, etc. c. analyse the pay-out ratio d. When evaluating the pay-out ratio, compare the current pay-out ratio to historical figures e. A quick analysis of a company's cash flow statement can tell you a lot about its ability to continue to pay its dividend (Wallick, 2011) Drawbacks: The Problem with this approach despite showing performance a company does not necessarily make profit for quite some time, so despite analyzing that a company’s performing well throughout the year if it fails to give any profit then they are not liable. The last, but not the least problem with dividends is double taxation. Suppose, for ?1000, an investor buy dividends of two companies in the ratio of 2:3. Now suppose both the companies earned good profit at the end of fiscal year and now have to pay its dividends to its shareholders. The company holder will first have to pay tax on the income and the profit that it generated, but the shareholder also has to pay tax for tax on dividend money that it owns. This has been one of the foremost reason for criticism of dividends and most discouraging reason to invest in it. Method 4 Basic Plan: Opening an account with a broker, this method comes in handy if a person trying to look into long term future in stock exchange. The reason for the employment of this method is most rational because a broker brings in experience, which is necessary for a new broker. Stock exchange is a game of intense manipulation, analysis and risk-taking; stock broker or more specifically an experienced stock broker brings to the market the thing that is needed the most. The best thing regarding opening an account with a stock broker is that it develops a sense of assurance in the mind of the investor regarding his money (Sincere, 2007). Another benefit of stock broker is, his or her contacts with the members of the stock exchange and that’s the influence which, attracts more investors because in stock exchange people do not invest and rely unless they make substantial contacts. Along with it they need to know, who to trust and whom not to because every person in stock exchange works for profit and as the saying goes, profit of one is the loss of the other. Becoming ruthless while at the same time being pragmatic in buying or selling stocks is what needed here. The broker will be the person who will be pragmatic while the investor will be the person who will be ruthless in decision making and a combination of the two will probably if not definitely, lead to profit. Drawbacks: Even though this method is the best (see below), but this method has its risks. First, very recently security and exchange firms across the world have been indicted of unprecedented risky methods and frauds, so there is a risk that before opening an account with any broker necessary homework is done i.e., necessary background information, broker’s association with a firm and its status as well (Prada, 2009). A drawback of opening an account with a broker is that, a broker has nothing to lose while the investor has everything to lose. This creates a sense of over-confidence in the mind of the investor and surprisingly is what caused the recession i.e., excessive risk-taking. Another drawback of opening account with a broker is increase and decrease in amount profit that a person owns because as an investor 1000 pound investment is not very high and the investor shall always be ready to pay the fees. Nobody gets something for nothing. The best thing about this option is that for a newcomer to know the basic culture of the stock market and its inclination.(Becket, 2002). It goes without saying for a person to learn how to drive a car, he at first drives with an experienced driver sitting by his side, in case he makes a mistake the instructor can tell him the right way to drive. Even if the investor must pay the broker fees for the services that are rendered, it’s still better than the remaining options because with that fees comes experience and a chance to enter a market that can make people millionaire with someone looking behind their back. One must spend money to make money and this is definitely the way to go, but one must make sure that the investor should have knowledge of more than addition, when he goes to stock exchange. The ultimate decision must always be that of investor instead of the broker, if the plan has to work efficiently because when it comes to money democracy never works, decision has to be made by the investor like dictator because it’s the investor’s money not of the broker. The reason for stating the last reason is that if success occurs the person responsible is broker and if failure occurs the responsible person is investor. Method 5 Basic Plan: Another way, which is the least risky, but also brings out least profit, is the idea of penny stocks. Penny stocks are the stocks in, which the price of stock is usually less than $1 or ?1. This method has the least risk because it equalizes, both profit and loss within a minimal level (Leeds, 2011). The reason investors in FTSE or other big exchanges in England of huge loss, is because of the fact that if the share price falls they fall drastically and if it raises it rises quite slowly. In penny stocks, the price does not effect much on either sides. Drawbacks: One drawback of investing in Penny stocks is that the organizations have low liquidation worth (Bowser, 2000). In case a company goes bankrupt, it is very hard to sell its shares because of the low market value of that company, resulting investors unable to get the money when they need it because the company is unable to sell its stock. Another disadvantage of this type of trading is that, since the value of the stock is less than ?1, therefore stocks are bought in bulk. Consequently, it creates an artificial hype around the Penny stock. Next big companies do press releases, email blasts and inflates websites of false information, which results in lots of people buying penny stock and then the investors sells it at a price higher than the paid amount. This strategy is called “pump and dump”(Indergaard & Tillman, 2005). This is the main advantage of Penny stock because low profit makes it highly undesirable stock to invest in, despite the considerably less risks involved. Another drawback of Penny Stock is regarding its value once you buy them. Considering a penny stock of ?1000 is bought and a person waited for 2 weeks to see in, which direction the market flows and what is the behaviour of the market. Thus, if ?1000 shares increase till ?1300; even than the investor finds it difficult to sell his shares as people take less interest in buying penny stock shares and it would reduce the worth of shares subsequently. People know less about the existence of such stocks and are not aware of its working as well (Madura, 2010). For example, a company’s worth ?1 billion and it decides to go public. If it sells each share for the price of ?100, then the total no. of shares will be 10 million. If the company decides to divide the value in 100 million shares then the value will be decreased to ?10, and if the company decides to make 1 billion shares then the company will automatically be selling penny stock to make larger profit. This will result major earning for the company, but the investors will be chasing the profit among each other for the money. Best Plan The best plan among the five mentioned above is method no. 4, i.e., to open account with the broker. This plan is the best considering that the possibilities are endless and new methods or options are open to scrutiny and there is no divine revelation as to how one must invest his or her money. The best thing about this option is that for a newcomer to know the basic culture of stock exchange is the guidance of the broker. Even if the investor must pay the broker fees for the services that are rendered, it’s still better than the remaining options because with that fees comes experience and a chance to enter a market that can make people millionaire. It divides the responsibility and assigns the power in both hands of the investor and broker. Worst Plan: The worst plan among the five plans mentioned above is the method of buying stock at the time rumors flow into the market. One the reason is mentioned above i.e., in case rumor turn out to be true than then there is loss in every possible way and the likelihood of money to recover remains thin. Another reason that this method is the worst of all is because this plan is based on gut feeling not on pragmatic approach. Even though in this plan the risk is high and as the saying goes, the higher the risk the greater the reward, but the risk is too high here for anyone in his right mind to earn money in stock exchange. Thus, the risk of law-suits with regard to spread of rumors and creating unnecessary uncertainty in the market, which might lead to development of rivals in stock exchange increases through leaps and bonds. The worse thing about this method is that it cannot even work with the combination of other four plans mentioned here because I. Being new to the market a person cannot evaluate the rumor for its truthfulness. II. This might not also work if a person opens an account with experienced broker and his approach doesn’t agree with the investor’s, in getting rich instant plan, which rarely works and in some cases never. III. This plan is useless in dividends because dividends are based on long-term investment so to talk about rumors in this scenario is of no use. IV. The last method is penny stock, the trading of penny stocks is so slow that there might not even be the chance to act on a rumor or in times of uncertainty on when to buy penny stock and when not to. And the biggest problem with Penny stock is that it’s difficult to find people who would buy it. To sell penny stock is not easy task as people usually go for big companies where trading happens at least every hour or every day. List of references Becket, M. (2002). How the Stock Market Works: A Beginner's Guide to Investment. London: Kogan Page Limited. Bowser, R. M. (2000). Penny Stock Winners: True Stories of Successful investors. Madison: Marathon International Book Company. Cassidy, J. A. (2006). Concise Corporations Law. Annandale: The Federation Press. Farrell, C. (2011). Gulf of Mexico Oil Spill. New York: ABDO Publishing Company. Top of Form FIELD, A. J. (1984). A New Interpretation of the Onset of the Great Depression. Journal of Economic History. 44, 489-498. Bottom of Form Graham, B. (1985). The Intelligent Investor: A Book of Practical Counsel. London: Harper & Row Ltd. Indergaard , M., & Tillman, R. (2005). Pump and dump: the rancid rules of the new economy. New York: Rutgers University Press. Ian Wallis. (2012). What does Facebook’s $104bn IPO and share price fall mean for the UK’s digital landscape?. Available: http://www.growingbusiness.co.uk/what-does-facebook-s-104bn-ipo-and-share-price-fall-mean-for-the-uk-s-digital-landscape.html. Last accessed 4th June 2012. Leeds, P. (2011). Invest in Penny Stocks: A Guide to Profitable Trading. London: John Wiley & Sons Inc. Lloyd, T., & Thomson, P. (2011). Women and the New Business Leadership. London: Palgrave Macmillan. Madura, J. (2010). Financial Markets and instituitions . London: South-Western Cengage Learning. Prada, A. (2009). Framing Finance: The Boundaries of Markets and Modern Capitalism. Illinois: University of Chicago Press. Prade, H., DuBois, D., & Bouyssou, D. (2010). Decision Making Process: Concepts and Methods. London: John Wiley & Sons Inc. Sincere, M. (2007). Understanding Options. New York: The Mcgraw Hill Companies Ltd. Wallick, S. H. (2011, January 26). First Person From a Stock Expert: Tips for Identifying Solid Dividend-Paying Stocks. Retrieved June 4, 2012, from Yahoo: http://voices.yahoo.com/first-person-stock-expert-tips-7492974.html?cat=3 Read More