How money is made from stocks and shares: the building blocks
Chapter 9 of "Getting a Better Class of Enemy", my investment book
I'm writing an investment book called "Getting a Better Class of Enemy - Money, Markets and Manias". As I write the chapters, they will be made available to paid subscribers to OfWealth. Previous chapters, along with the Preface and Chapter Plan (which are free to all readers), can be found by clicking on this link.
The reason for the title is that, as your wealth grows, there are a lot of potential "enemies" that will try to take it away from you. These are explained in Chapter 1.
"Money can't buy you friends, but you do get a better class of enemy."
Spike Milligan, Irish-English author and comedian (1918-2002)
Chapter 9 picks apart the individual building blocks that result in profits (or losses) from investing in stocks. It's important to have a good understanding of these basics, both to improve the chance of profits and to contain the risks of losses.
Also I've included some history on why we call them "stocks", and explanations of other terminology.
As always, feedback from readers is encouraged.
Please send emails to ofwealth@substack.com
Chapter 9:
How money is made from stocks and shares: the building blocks
"To succeed in it the investor must first understand the paradox that investment is simple but not easy."
Richard Oldfield, veteran British fund manager, from the introduction to his book "Simple But Not Easy" (first published in 2007).
In this chapter my aim is to lay out the building blocks that combine to make a stock investment successful and profitable over time, or otherwise. The concepts are relatively simple to grasp, but often ignored by too many people. This explains a large part of why they get themselves into trouble in the markets.
Of course, knowing the building blocks doesn't itself lead to success. There is still the harder part of selecting the right sort of stocks in the first place. Later chapters will provide guidance in that regard. But investors are highly unlikely to get ahead without knowing about the fundamentals that combine to drive overall investment profits from stocks.
Earlier chapters made reference to how stocks have significantly outperformed historically, over the long term. That's when compared with other mainstream investment choices, such as government bonds and bills, cash deposits or precious metals.
This is not by chance. There are good reasons why stocks, taken as a whole, outperform in the way that they do. None of that is to say that stocks always do better than other asset classes, especially over short periods of time. But understanding a bit of basic theory explains why it works out that way over longer periods. It also improves the chances of making handsome profits over all time horizons (the short, medium and long terms), and avoiding losses overall.
This chapter will explain the fundamental mechanics, with more detail in chapters 10 to 12. Chapters 13 and 14 will look at how to pick good companies, avoid bad ones, and use valuation techniques to your advantage.
First of all, we must focus on the building blocks that lead to profits or losses for investors in stocks, when those blocks are combined together.