How To Invest Your Money Wisely

The most important thing about investing in stocks is that it generates passive income, not active income. There are two ways of making income.

The first one is active income. Active income means you go to work & you do a job & you actively earn your income. You have to work to earn some money here.

The other kind of income is passive income. Passive income means you own an asset like a stock that produces income for you. Once you own it you get paid without having to do any work. You get your dividend income even when you are sleeping.

As Warren Buffett says you need to have a passive income, otherwise you have to work until die.

“If you don’t find a way to make money while you sleep, you will work until you die.”

Warren Buffett

The investment strategy that made Warren Buffett a billionaire is value investing. Value investing can generate healthy returns for your investment.

The key idea behind value investing is buying stocks at a price below their value. The important thing we need to identify here is that this is a stock below its value.

The key to value investing is determining the intrinsic value of the business. Once you identified the value the only thing you have to do is buy the stock below its intrinsic value.

There is no exact equation to measure the intrinsic value of each company. However, you can use some basic financial ratios to evaluate each business.

PE Ratio

The price-to-earnings ratio, PE ratio is used to identify how much time this stock takes to cover the initial investment.

PE Ratio = Current Market Price / Earnings Per Share

Let’s say there is a company called Company A & the earnings per share of the company for 2023 last financial year is $10. The share is currently traded at $100 per share. By dividing the current market price of $100, by earnings per share of $10, you get the PE ratio of 10. A Pe ratio of 10 means it will take 10 years to cover the initial investment.

When it comes to the real world we focus on low PE ratio companies. Low PE ratio companies take only a low time frame to cover the initial investment. It is a good sign if we can get our investment as soon as possible.

Dividends

Dividend Yield = Dividend Per Share / Price

How much a company pays out as dividends to the shareholders.

Dividend Payout Ratio = Dividend Per Share / Earnings Per Share

The proportion of earnings a company pays in dividends & how much it re-invests in the business.  

If a stock earns $20 a share, the dividend per share is $10  & its market price is $100, the dividend yield is 10%. The dividend payout ratio is 50%.