Let’s say you work for a bank as a loan officer. Every day, potential borrowers come to you for a loan. You want to reduce losses from bad loans and increase earnings for your bank. Which applications get approved, and which get rejected?
To separate potentially good applicants from bad ones, you need documentation: IC, payslips, tax files, EPF statements, bank statements, CCRIS, CTOS. These help you to assess creditworthiness.
If the applicant is applying for a mortgage, you would also need a valuation report on the property as security for the funds to be disbursed. This report allows you to calculate the maximum loan so the bank can better recoup the principal if there is a default.
After doing a detailed background check on the applicant and the property, you refer to your institution’s policies, processes, systems and structures that govern how you decide on loan applications. You assess all the information and decide to accept or reject.
Now, what if a bank doesn’t have a credit policy? Without background info and valuation reports, it would be virtually impossible to identify a creditworthy person. With higher risk of undependable customers, the bank would face greater losses owing to more defaults on repayments.
Long story short, a profitable bank needs a strong credit policy.
What does this have to do with investing?
Just like the bank scenario above, good stock investors need strong investment policies. Buying stocks without reading financial reports can be likened to bankers who lend to any Tom, Dick or Harry without doing background checks.
If you buy stocks without reading reports and believe you are investing – well, you are not. What you are really doing is trading, speculating or gambling.
Now, what if you don’t know how to read financial reports? Can you still buy stocks?
Yes, you can. But please keep in mind you are still not “investing”, strictly speaking. It’s OK if you don’t know how to read financial reports. Everyone needs to start somewhere. Luckily, it is a quick study.
As long as you know how to add, subtract, multiply, and divide, you can learn to do it. No algebra, trigonometry or Pythagorean theorems are involved. There are many online resources that could help you with this.
Once you master the skill, it will serve you for a lifetime. You develop a genuine ability to identify stocks that are investment worthy and separate them from boatloads that are not. It’s how investors become rich.
What about unit trusts and ETFs?
How do you pick a decent unit trust fund or exchange traded fund (ETF) from the thousands available? Can you depend solely on a unit trust agent? How would you know if he or she is dependable?
The simple truth is, if you don’t educate yourself on these matters, you won’t know what questions to ask. It isn’t a case of whether stocks are better investments than unit trusts and ETFs, or vice-versa. Instead, the more helpful query would be: I’m interested in stocks/unit trusts/ETF. How do I become a good stock/unit trust/ETF investor?
Becoming good is the key term here. And to become good, you need to pick up investing skills, including reading financial reports. And once you become good, you can make anything work.
So, where do you start?
Like a good banker, you can begin by picking up two main investing skills, namely fundamental analysis (finding financially solid stocks), and valuation (identifying undervalued stocks).
Again, there are many useful resources online that will help. So do your homework and build your basic skills before making any investment decisions.
This article first appeared in KCLau.com. Ian Tai is a financial content writer, dividend investor, and author of many articles on finance featured on KCLau.com in Malaysia, and ‘Fifth Person’, ‘Value Invest Asia’ and ‘Small Cap Asia’ in Singapore.