How to buy stocks in Canada - A definitive and informative guide to investing and purchasing stocks
So, you want to learn how to buy stocks? We know the world of investments can be daunting at first. But if you are reading this, there is no doubt you have an itch to understand more about equity trading and how to participate in the world of capital markets. Before we learn how to buy stocks in Canada, it's imperative that you actually know what a stock is. Purchasing stocks without first knowing what you are buying is like purchasing a car with a manual transmission with no knowledge of how to drive it. You want to learn how to drive the car before you start cruising around downtown Toronto.
So what exactly is a stock?
A simple yet loaded question, of which there are a plethora of answers that can inundate even the bravest of souls. Simply put, a stock provides you with certain rights - such as voting in shareholder meetings, earning a portion of dividends and the right to sell your shares to a third party. Whether you are learning how to buy stocks in Canada or anywhere in the world, this is the case.
However, owning a share does not give you rights to assets of a corporation - a common fallacy perpetuated to the hilt among many. In the eyes of the law, an organization is treated as a separate entity (a person). As a result, the tables and chairs that one would see in a Royal Bank are owned by the company, not the shareholders. In buttoned-down boardrooms, this is known as separation of ownership and control.
So now that I know what a stock is, I want to know how to buy stocks in Canada!
Buying stocks is pretty easy, regardless of where you are situated in the world today. You simply sign up with a discount broker online or even a broker from a big bank such as RBC Direct Investing. From there you simply fund your account and purchase the shares you want. The real question aspiring investors should be asking themselves is how do I buy GOOD stocks? Any person over the age of 18 can simply open a brokerage account and start purchasing stocks. But without proper knowledge, they will go broke.
Many falsely assume that investing is all about luck, others who purport themselves as experts would argue that it's about having an innate ability. All such claims couldn't be further from the truth. Yes, investing is an art to a certain extent, but it is also a science - a skill that can be learned with repetition and practice.
I know I need to pick good stocks, but how can I tell? What drives the stock market up?
Before we commence with details of the stock picking process, it is imperative to understand the forces that drive the stock market. A stock market is a marketplace where you buy and sell stocks. Thus, the value of those stocks in the stock market is determined by the forces of supply and demand, forces which are a function of the market's view and firm's need for capital.
In other words, if the price of a stock is high, the market players are promulgating their optimism about that stock. Woe to those who at this point do not identify the fact that such views can be based on false or hyped information. In the early 2000s the market believed based on anecdotal information and asinine valuations that tech stocks were to be highly valuable. Such beliefs led to the creation of a bubble and ultimately, a crash.
How do I pick those diamonds in the rough? I want to know how to pick profitable stocks!
The intrinsic value of a stock is the amount the stock should be worth on the market. The intrinsic value of a stock may or may not be the same as its market value. This is why there is money to be made in the stock market. If your analysis is good, your intrinsic value calculations will be correct and you will know whether a stock is overvalued, or undervalued.
An example will clear things up. Let's say that the market share price of Orange Juice Inc is $50. But based on your analysis, you determine that the value should be $80. Thus, there is a POTENTIAL upside and an opportunity to make $30 in profits.
How does one determine the intrinsic value of a stock? Short answer - by developing the right mindset and doing quality research. Read how to calculate the intrinsic value of a stock here. Keep in mind that although by common misconception the stock market is often referred to as a zero-sum game, it is not. That being said, there are winners and there are losers. More often than not, the losers are investing on emotion, or simply lack knowledge. Which leads us directly to our next point.
To be good at picking stocks you need to think like a businessman, not a stock picker. We have proof that such a mindset works, proof worth $70 billion - net worth of Warren Buffett. The greatest investor of our time thinks of himself as a businessman, not an analyst or a stock picker. Warren Buffett has often made claims that the Intelligent Investor by Benjamin Graham was the best investing book he has ever read.
When it comes to research, the first step is to understand that a good industry does not mean a good stock. A rising tide may lift all ships, but a weak ship will go down into the abyss sooner or later. Case in point - Noodles and Company, listed on the NASDAQ. Even though fast casual dining is popular among Americans, shares of Noodles and Company have been falling since its initial public offering in 2013. That being said, just because you are learning how to buy stocks in Canada does not mean that a weak or strong industry here is the same in the USA or other parts of the world. Canada is one of the largest exporters of wood in the world, exporting exponentially more than the United States. Another example would be although Canada's oil and gas industry accounts for 16 percent of all total exports in the country, the United States has exported more than 30 billion dollars over and above Canada.
I want to know how to buy stocks in Canada that are going to be the next big thing, is it possible?
Stocks need a catalyst to move, which is a double-edged sword because the price can move in either direction. Examples of good catalysts are change in regulations, an acquisition of a company etc. If you are learning how to buy stocks in Canada, you've probably been keeping a keen eye on cannabis stocks. Most (not all) Canadian cannabis stocks moved considerably due to change in government regulations. Monster beverage corporation had an excellent marketing strategy, which allowed it to maintain a long period of hyper-growth and provide lucrative results. But beware! We are not trying to insinuate that one should invest based on hype - an excellent way to make grave mistakes.
Also, one should not fall into the trap of looking for the next big thing. Such an endeavor usually encumbers one into inaction and causes a lot of frustration. The next Facebook and Apple are out there, but it is highly unlikely that you will discover these diamonds in the rough before the industry experts. By experts, we mean individuals who are involved in the nitty-gritty of the industry because of their professions. For instance, a professional grass-cutter will automatically know more about the latest tech in grass care because of his industry contacts as compared to your average everyday neighborhood gardener.
How to buy stocks that will provide consistent returns
To become good at investing, one needs to do the heavy lifting i.e. quality research. If that is not your cup of tea, the next best option is to invest in blue chip stocks - large, established and financially sound firms that have existed for long periods of time. When teaching people how to buy stocks in Canada, we often preach Canadian bank stocks. They are a great long-term investment. These banks are protected by mammoth, almost impenetrable barriers to entry because of Canadian Banking Regulations. The industry is like an oligopoly, and Canadian banks make a handsome profit each year, which in turn means great returns for investors via consistently rising stock prices and dividends. While it is good to have blue chip stocks in your portfolio, a portfolio can really maximize its returns if you choose to dive into some speculative areas.
We aren't advocating to go out and gamble, but if you are a brave heart, unafraid of grappling with research and numbers, it is best to follow a structured approach to stock selection. The first step - run a screen based on certain investment criteria.
Screening stocks - How to buy stocks in Canada using fundamental analysis
Screening a stock is a way of separating the wheat from the chaff. Numerous screening tools are available online, such as Morningstar and Zacks, which allow you to perform this operation with utmost ease. Because we are obviously learning how to buy stocks in Canada, it would be inappropriate to not include a great TSX screener. TMX Money is the best in the business in our opinion. That being said, it's not about swinging the hammer, it's about knowing where to hit - a feat that can be achieved with ratios. But like everything in life, all ratios are not made equal - it is best to focus on a few instead of making your life difficult with hundreds that provide little additional value. Here is a stock quote from Imperial Oil using Questrades IQ Platform. You can reference this picture when looking over these terms, as most stock quotes will include them.
PEG and P/E ratio - The go-to ratio for almost everyone in the industry, a comparison of the firm's stock price against its actual earnings (P/E stands for price-to-earnings). We go in depth on the P/E ratio in this article.
Ratios on their own are pretty useless, you need an appropriate yardstick for comparison. A good choice would be the industry average. The P/E ratio for the firm that you are interested in might be 30, which is extremely high. However, if the industry average is 60, your stock is a steal, provided it is sound in all other areas.
An ingenious enhancement of the P/E ratio is the PEG (price-earnings-growth) ratio. As a rule of thumb, look for companies with a PEG close to 1.0, which implies that the market's expectations are based on realistic assumptions about the firm's growth prospects.
Let's assume that the P/E ratio of a firm is 10, and the expected growth rate is 5%. In this case, the PEG is 2 (10 divided by 5). Even though a P/E of 10 might be low compared to industry average of 15, the PEG raises a huge red flag.
Return on equity (ROE) - The net income earned expressed as a percentage against shareholder investments. Plain English: A measure of the management's ability to use money invested in the business. If you want to beat the market, a ROE of at least 10% is essential.
Debt-to-total capital - An extremely important ratio. Too much debt can cripple a business during tough periods, eventually leading to bankruptcy. Furthermore, this ratio is a good way to gauge the management's claims. For instance, they may claim that they are going to double their business by borrowing money from banks. But if the D-E ratio is 2, no bank will extend a loan to the firm. Look for firms with D-E less than 0.5.
Institutional ownership - Percentage of stocks owned by big institutions such as mutual funds, pension funds, endowments, hedge funds or other large investors. There are two ways to look at this metric. High institutional ownership means that big analysts are confident about future prospects of the company. But this also limits upside as the stock is not 'hidden' from big players. Around 50% institutional ownership is the sweet spot.
Earnings per share (EPS) - Provides an assessment of the company's historical profit growth rate. 5-10% growth is healthy.
Business Size - Size of the business will determine the classification of the stock. Anything less than $200 million will fall in the small cap/penny stock category. Smaller companies are more risky. If you are interested in investing in penny stocks, check out our article on what exactly a penny stock is.
Other non-numerical screening factors include:
Geographic location - Companies in developed nations are more stable as compared to those in developing nations.
Business Sector - Sectors such as tech are inherently more risky as compared to other sectors.
After running the screen, the next step is to read the company's financial statements. These are usually available on the Securities and Exchange Commissions website, or in the company's annual reports.
The balance sheet, profit and loss, and cash flow statement will be the focus of your analysis. Of these three, cash flow statement is the most important for two reasons. First, cash is king when it comes to business. If a firm does not have enough cash, it will go down sooner or later. Second, cash cannot be 'cooked' like the balance sheet or profit statement. If the firm is trying to fool investors by showing a good cash flow financed through high-interest loans, those numbers will be evident on the statement.
How to buy stocks in Canada using qualitative analysis
Now you can relax and take a break from the numbers. It's time for qualitative analysis. Start with the quality of the management, something very hard to assess but probably the most important. A good management or CEO can make or break the company. McDonald's would not be a multi-billion dollar fast-food chain if it weren't for Ray Kroc's vision. A good place to start is the historical performance of the management.
An excellent way to learn about the company, and develop your own business and analytical skills, is to listen to the conference calls, where management of the company answers analyst questions and discusses its pain points and future plans.
If you were to follow the advice thus far, you would be better than 90% of investors out there. But beware of a pitfall at this turn, you may get bogged down with analysis and try to be too perfect. If there were a perfect system, everybody in the investing community would be a billionaire.
Picking the right broker to buy stocks in Canada
Knowing the destination is not enough, you need a vehicle to reach the final point. The vehicle in our case is a brokerage account, something that is as easy to open as a bank account. In fact, it may be a good idea to open a brokerage account even before beginning your research because most brokerages provide tools that can be conducive to research.
Selecting a good broker is a research project in itself. Some have unnecessarily complex interfaces that can confuse and frustrate even the most seasoned investor. You can view our page to learn about the best brokers in the US and Canada.
Moreover, there are different categories of brokers. We personally prefer online brokers as they provide a no-frills and fast approach to investing.
Discount/Online brokers: As already mentioned, these are the simplest of all categories of brokers. They are order takers and not in the business of providing advice. For those who are uncomfortable with using an online terminal, an option to order over the phone is also available.
Online broker with assistance: As the name suggests, these are discount brokers that provide advice, which is a little less than full service consulting. Such brokers usually provide monthly newsletters and investing tips, and may provide more research options as compared to a straight discount broker. For a beginner, all the numbers and charts can be highly intimidating, but just keep tinkering away with the terminal and you will be a master in no time.
Full-service broker: The traditional kind that has existed since the early stages of the industry. Their job is to assess your financial situation, perform comprehensive research and provide recommendations. In other words, they do the heavy lifting for you, which also implies that you trust them to have advanced analytical and research skills.
Money managers: Not really a broker per se, but worth a mention as most people confuse them to be one. First, to invest with money managers, you need a hefty amount of capital. Second, you are not really in control of making investment decisions. Everything will be done by the manager. There are some excellent money managers out there, who provide substantially better returns than the market. However, as mentioned before, you need to have a significant amount of capital and be willing to pay mammoth management fees.
Common terms you will find with your brokerage account when buying stocks
Sigmund Freud had to create his own terminology to explain ideas of psychology to the world. The same is true for brokers, they have their own lingo which may be confusing for a beginner learning how to buy stocks. Hence, it is best to learn some of the common terms.
Market Order: A buy or sell order that is to be completed instantly at the current market price. This is the simplest of all order types, and is best used when speed is more important than price.
Limit order: Opposite of a market order - price is more important. The goal is to buy or sell a stock at a certain price. A buy order is executed at a certain price or lower, whereas a sell order is executed at a certain price or higher.
Stop-limit order: A hybrid that combines the features of stop-loss and limit orders. When a certain price is reached the stop-loss turns into a limit-order - set to buy or sell a security at a certain price. As you may have surmised by now, this will require you to set two price points.
Congratulations! If you have read this far, you are no longer a beginner! A word of caution though, start small, real small. Don't be worried about missing an opportunity, they have existed throughout history and will continue to do so into the future. Once you get into the thick of things, that is, follow the markets, do analysis and learn more, you will be teeming with great investment ideas. On the other hand, if you invest all your money and end up losing it, you would have to start all over again, which can be an absolute drag.
For some, learning how to buy stocks is just too daunting and time-consuming. All they want is the market return, or a little more. In that case, exchange-traded-funds (ETFs) or Robo-Advisors are great options. ETFs invest in multiple securities which lead to diversification and thus, lowering of risk.
We hope this article helped you gain an understanding of investing in the stock market and how to buy stocks in Canada. Please feel free to share this article and like us on Twitter.