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Are You Investing in a Company or Just Its Stock?

Recall how you first got into stock investing. Maybe it was through friends’ recommendation, or from reading financial press or a money blog?  Regardless of your way in, it is essential to ask yourself this question at the outset: are you investing in a company or a stock?

The answer will determine your role in this investment, and in turn your strategy and methodology – all these will affect how successful your investment will be.

Two different vantage points

If you are investing in a company, your role is that of a shareholder – more precisely a part owner of this company. Your primary concern is, therefore, the present and future profitability, and ultimately the equity value of this company. You are entitled to share a piece of the profit (or loss as the case may be), as well as any subsequent increase in equity value.

On the other hand, if you are investing in just the stock, your primary focus would be the price of this stock at a given point of time. Your role is more like a trader, as profit is made from the buying and selling, and not holding, of the stock.

The two vantage points call for distinctively different approaches to stock investment.

Investing in a company

As a prospective business owner, you are in effect forking out a piece of capital and investing it on a business, quite typically for at least two years or more. As such, you would select a company based on its potential for profitability and appreciation in shareholder value.

Once you’ve identified a target of interest, you would wait for an excellent opportunity to acquire your stake at a reasonable price. And that’s probably the last time you’d scrutinize a company’s stock price – ultimately as a shareholder, you would be much more interested in the company’s operational and financial performance, and not so much the stock price. You would pay attention to factors like industry trends, competitors, quality of management and operations, because the change in any of these will have a direct impact on your business.

If you invest in a successful company, not only will you share a part of its operating profits or dividends, you would also enjoy the gain in shareholder value when you decide to liquidate your investment by selling your shares.

Investing in stocks

This is an alternative and fundamentally different way of investing. As a trader, you make money from the buy-sell price differentials. Volatility is your best friend, because it multiplies the profit margin that can be made. There are many forms of trading, involving different instruments and modes of operation. It ranges from day-trading stocks, to trading futures, index futures, warrants and other derivatives – the repertoire itself keeps evolving and expanding. Regardless of the form of trading, you need to be at all times switched on to market prices, and any factor that would affect price movements. Trading usually requires a certain amount of capital, hence the frequent use of leverage.

As a trader, the underlying business of the stocks or futures or warrants is not a key concern. Much more important are factors like total trading volume at play, price and trading momentum, etc.

Vast fortunes have been made in trading, success at which requires a specific predisposition and set of skills not dissimilar to that of a world-class poker player. Some forms of trading involve high risk, especially those that use leverage.

Which is better?

There is no right or wrong, good or bad answer – just what is right for you. At Fools, we advocate value investing, which means we invest in a business for the long haul. We believe that it is the best and most pragmatic way for the average retail investor to accumulate wealth.

No matter which approach you take, investing with the appropriate mindset is crucial for success. Trouble arises when amateur investors wander into trading – usually driven by promises of quick profits – without adequately understanding what they are in for, nor an assessment of their own level of expertise and risk appetite.

And that’s exactly why it is so important to ask yourself this question – are you investing in a company or just its stock?

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