So, you want to invest in stocks. The first thing to know is, if you're really a beginning investor, you might do better to consider investing in a group of stocks, or "portfolio," selected by someone else, like a professional, like a mutual fund or even an exchange-traded fund (ETF).
If you already have some investments like that, and want to try and do better picking your own stocks in which to invest, here is how to go about it.
The process of researching and choosing a stock or a portfolio is intended to minimize your risk of losing your entire initial investment, and to have the potential to earn higher returns with an investment strategy.
How to Research Stocks in 12 Steps
1. Think About Companies That Sell Something You Know About or Like
Remember a stock certificate represents your investment in, or share in the ownership of, a publicly-traded company. When you own stock, you own part of a company. You've given that company money for its business, its growth, and its profit-making potential.
All the advice in the world isn't going to make you feel better about investing blindly. If you've never heard of the company, have no idea what it does or how or even if it makes money, and no one you know has or you've never seen its products either advertised or sold, you're going to hand your money to the person with the most convincing argument. Which isn't a smart way to invest.
When you're buying products, think about why you choose one over the other, or why a business in your neighborhood like a restaurant or bakery, appears to always be crowded or busy as opposed to some other. And above all, don't just buy a stock because someone you know recommends it. The market adage, attributed to Joseph P. Kennedy, goes: "You know it's time to sell when shoeshine boys are giving you stock tips."
2. Get an Idea of the Industry to Which the Company Belongs
For instance, if you're considering investing in a company in, say, mobile applications, consider if the company is well known, has a long history, or is new, like a start-up. Look to see if regulations on the industry could affect future prospects on the company, such as environmental concerns. And looking into a company's history will help indicate if it is nimble and adaptable, or seemingly a bit entrenched and in search of a new product or strategy to reinvigorate growth.
3. Look at a Company's Required Report of its Financial Condition to Regulators
The National Association of Securities Dealer's Automated Quotation system, known by its acronym Nasdaq I:IXIC , recommends researching the financial and other corporate information required by and filed with the Securities and Exchange Commission, the U.S. stock regulator.
The SEC has its own online searchable database of such filings, called EDGAR. But there are a number of sites that will let you look up a company's required financial reports if you know the company's corporate stock trading symbol. The easiest and, these days, possibly quickest way, is to look up a company's own website and look for its "investors" page. That's where information for investors is kept, and published. Invariably, because all smart investors want to research a company, this is where you'll find the required reports.
Once there, look at the company's revenue, which should give you an indication of how much money the company is either making or, at least, made as recently as the last time it had to report it. Growth is essential for a stock to increase in value. And an increase in a share's value is the quickest way to see returns on your investment.
Next, look at Earnings Per Share (EPS), also in the financial report. While revenue indicates how much money is coming to the company from sales or other income, EPS indicates how much money is going back to stock holders like you hope to be.
4. Compare the Price-to-Earnings Ratio With Others in the Same Industry
Just as, being an investor, it can profit you to consider the industry in which the stock that interests you operates, it is always a good idea to observe how a particular company's earnings are doing compared with the earnings average of other companies in the same industry or sector.
Professional investment advisers frequently look for undervalued stocks. What that means is they look for stocks that are relatively inexpensive for each dollar the company earns. The P/E ratio measures that.
If a company's Price-to-Earnings, or P/E, ratio is above average for its particular industry, that's usually a signal the company is doing well enough for you to consider investing in it.
Again, this information on stocks can be found by doing a simple online search, and is often included in reports on the stock's price by various websites.
5. Consider the Company's Price-to-Earnings Growth Ratio (PEG):
Unlike the P/E ratio itself, the PEG ratio accounts for growth. To calculate a PEG ratio, you divide the stock's P/E ratio by its expected 12-month growth rate. If the ratio is less than 1.0, it has good prospects. If, however, it has a value greater than 1.0, its prospects are not that bright.
6. Check Out Its Weighted Alpha
When publicly researching a company online, you can even seek its weighted alpha numbers. The weighted alpha figure, which often is included in more in-depth quotes than just the day's up or down activity, measures a year of growth but with an emphasis on the company's most recent price activity. A positive weighted alpha suggests the stock price is moving higher, while a negative one suggests the opposite.
7. Consult With a Brokerage or Otherwise Use Online Tools
After you've tried to evaluate the health of the company you're interested in or in which someone suggested you consider investing, you should consult with others who have conducted their own analysis of the company's potential. Naturally, for this, you'll want to look outside the company, and your best chance is reviewing the recommendations of analysts. These are professionals who make their living analyzing and critiquing investment opportunities.
You can frequently find such information merely by using a search engine and searching the name of the company you're interested in, and 'analyst recommendations.'
8. Explore Earnings Forecasts
Just as a stock's past earnings reports are helpful in deciding whether or not to invest your money in someone else's business, so too are future earnings forecasts from both the company's executives and analysts. Naturally, if a consensus of analysts expect earnings to improve consistently, it is a positive indication. Likewise, if a consensus of analysts expect earnings to lessen or even result in a loss, you might want to think hard about investing in that company.
9. Pay Attention to Earnings Surprises
When looking into a company's financials, consider what analysts are suggesting about the information you find.
Ahead of a company's announced date for reporting its finances, analysts will start to predict what they expect the EPS of the company to be. As an investor, if a company reports EPS below analyst expectations, it usually will be reflected in a decline in the stock's price, and visa-versa for EPS above expectations. When considering an investment, or whether to continue to hold a stock or sell it, you want to see its earnings at least meet, consistently, if not beat, analyst expectations.
10. Look at Its Earnings Percentage Growth
This is another number the Nasdaq I:IXIC recommends investors consider in making a stock pick. Because it will give you an idea how much professional analysts think the company's earnings are likely to grow per year for the coming five years.
If the long term, or 5-year, number is 8% or greater, the stock's prospects are bright. If, however, the percentage of per-year growth is less than 8%, you might want to consider a different investment. Again, a number of websites that cover a stock's day-to-day movement provide this information.
11. Consider the Volume of Stocks and in Which Direction 'Insiders' Are Trading
In the investment world, "insider trading" means the volume of shares either bought or sold of the company by its managers and executives. If the managers and executives are confident of the company's ability to grow and provide solid returns on investment, it will be indicated by their buying stock in their own company. Similarly, however, if they are selling their stock, it can be an indication they've lost confidence in the company they work for, and that is a very bad sign. If the "net" insider activity on the stock for the past three months has been positive, it is a vote of confidence. If, however, it has been negative, it is an indication of a loss of confidence.
12. Don't Be Surprised by Volatility, Don't Panic, and Don't Forget to Sell
According to experts, an individual stock is always going to be more volatile than a diversified mutual fund. To get an idea of how widely the stock you're interested in has moved within a year, look at its 52-week highs and lows.
Still, just as you need a strategy for researching and selecting stocks, you should also have in mind a set of criteria indicating when it's time to sell. If you have a strategy to guide you when to sell, it will help steel you against panic over a short-term move. Remember, also, the amount your stock may gain in value isn't set until you sell. So a plan to sell when certain criteria is met can also help you reap gains before a downturn, as Joseph P. Kennedy, the first SEC Commissioner and father of President John F. Kennedy, did.
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