The stock market is a complex, intricately detailed money-making machine. Its scope and size can be overwhelming to those who aren’t professional stockbrokers or day traders.
As exciting and fascinating as the stock market can be, it can be hard for common, everyday investors to know how to take advantage of it — by finding which of the market’s many stock offerings have the best chances of future growth and solid returns on investment.
Especially now that stock market customers have more direct access to financial tools, it’s easier for them to evaluate potential stock investments and find the ones that will suit their investment goals. We’ll go over some of the basic, most effective steps to answer the question, “How do I learn to pick stocks?”
Set my goals
The stock market is a flexible investment resource. It accommodates several investment styles: aggressive traders looking to build profits, relaxed traders seeking to grow assets safely, and all the varying degrees in between. The very first step in picking winning stocks is to decide what your investment goals are.
Low-risk, blue-chip stocks
Investors who want safer stocks with minimal risk gravitate toward companies that have shown consistent, steady results in all economic conditions. These investors lean toward “blue chip” stocks: familiar companies that rule the market, generate reliable profits time after time and bounce back quickly from economic downturns.
Companies like Apple, Bank of America, Coca-Cola, Disney, Johnson & Johnson, Walmart, and other behemoths are considered blue-chip stocks. While there are no 100% “guarantees” in the stock market, these companies are as close to “a sure thing” as you can get.
High-risk, speculative stocks
Other investors are more assertive. They look for companies that stand to make immediate profits and grow quickly to collect higher returns. These more active traders search for businesses that haven’t reached market saturation but show great promise.
An aggressive trader may buy stock in a developing small tech company that makes components for 5G cellular networks. They may invest in an international bank that serves newly emerging economies in Latin America, Africa, or Southeast Asia. Companies like these may have big paydays coming that will reward their investors handsomely, but they’re far riskier than blue-chip stocks.
Most individuals with multiple stock holdings mix these strategies to some proportion. They balance dependable blue-chip stocks with a couple of speculative, riskier stocks. The steady gains of big companies are bedrocks that offset the risks of emerging companies.
Value vs. growth
Wall Street differentiates these two investment strategies in terms of “value” and “growth” stocks. Value stocks are priced lower than many investors think they should be; they’ll pick up a value stock when they believe its fundamentals are sound enough to ensure sustainable success in the future.
Growth stocks are shares in companies that traders believe have exciting potential. They believe these developing businesses will experience exponential growth that will beat the pace of the overall stock market. These investors believe they’ll be able to sell their shares in growth stock and reap the profits, which are referred to as “capital gains.”
Almost all companies start as growth stocks. A select few go on to have enormous success and are now considered blue chips. Amazon is a great example: If you invested in Amazon in the ’90s, you were taking a calculated risk. Now, 25 years later, Amazon is a market dominator that’s the very model of a dependable, blue-chip stock. It’s the very rare success stories that growth investors want.
Diversify
Whatever your investment strategy, don’t put all your investment resources in just one or two stocks, even if you feel relentlessly positive about its prospects. Spread your investments across several different companies and business sectors. This alone can increase your portfolio’s potential. If you have five construction stocks undergoing a sector-wide recession, they can be offset by five tech stocks experiencing growth.
Research
Whether you’re after blue-chip, growth stocks, or a reasonable mix, don’t pounce on them until you’ve done due diligence and researched your options.
In the past, everyday stockholders relied on stockbrokers to research their buying decisions. The internet age has changed all of that. Modern stockholders have access to all the information they need to make informed and intelligent stock decisions. Financial advisers are still around, but their clients can readily obtain most of the initial information they need themselves.
What you’re looking for when you’re researching a company is its story. You’re looking for both numbers and narrative, a combination of statistical information and news items that gives you a clear profile of the stock you’re considering.
Quantitative research
Finding financial data is often the starting point when one looks for stocks, and there are multiple sources for getting this information about every stock on the exchange. Well-sourced quantitative data can provide a reasonable overview of the basic qualities — called “fundamentals” — that drive its success.
There are so many bits of data that it can be difficult to know which ones matter the most. But there are a few economic indicators about a company one should focus on to start with:
Revenue
This figure represents how much money a company brings in over a given time through selling its products or services. Revenue is usually the very first figure you’ll see on a company’s income statement. It’s the corporate equivalent of the “gross pay” you’d see on your work paystub.
Net income
Net income indicates how much money the company makes in profits after accounting for certain deductions: operating expenses, purchases of raw materials, taxes, value depreciation, and so forth. It’s a company’s “bottom line,” and true to form, it’s usually found near the end of an income statement. In the paystub analogy, it’s “take-home” pay — how much you get after taxes, withholdings, or other deductions that are counted.
Earnings per share (EPS)
Every company offers a certain number of shares in common stock. Earnings per share is a figure that divides a company’s net income by that number of shares. For example, if a company with 300,000 available shares posts a net income of $15,000,000, the EPS is $50. As you might imagine, companies with higher EPS are viewed as more profitable.
Price-earnings ratio (P/E)
After determining a company’s earnings per share, its price-to-earnings ratio is calculated by dividing a stock’s current price by that EPS. In that last example, if our company with $50 EPS sells its shares for $40, its P/E is 0.8 (40/50). If their stock price is $250, the P/E is 5.0 (250/50).
P/E tells a story about the company. If the P/E is high, the stock may be overvalued and is due for a correction. But it could also mean that investors have faith that it will increase in value at some point and turn into a solid growth stock. Similarly, a company with a lower P/E ratio may be undervalued, and a potential value stock. Or it could indicate that they’ve missed their revenue projections or run into other financial problems. Your research will hopefully explain why a company’s P/E is high or low.
Return on equity (ROE)
This figure is a percentage obtained by dividing a company’s net income by its shareholders’ equity, loosely defined as its current assets minus liabilities. For example, if our company with $15,000,000 in net income has $60,000,000 in shareholders’ equity, it has an ROE of 25%. ($15M/$60M = 0.25).
ROE is an indicator of how well a company’s leadership uses the money its shareholders give them through stock purchases. A higher ROE usually means the company’s doing well, generating more profit without needing too much capital from shareholders. A lower ROE may indicate that leadership isn’t investing shareholders’ money very wisely or efficiently.
While P/E relates to how profitable a company is, ROE reflects how well it’s managed. Many investors consider companies with ROE’s of 15% or higher potentially good stock buys. Many won’t even consider companies with ROE’s less than 10%.
One thing to remember when you’re researching a company’s financial details is that you’re dealing with the data that the company is making public. In some cases, this data may not be entirely accurate. Some companies may misrepresent their earnings to paint rosier pictures about their health. That’s what happened with Enron, which reported a 2000 net income that was more than 33% higher than the true number. That started a chain of events that brought their illegal business practices to light, eventually driving Enron’s stock price down 99% and putting them out of business.
This means that while quantitative, statistical analysis of a stock is crucial and mostly reliable, it won’t always tell the whole story. That’s where qualitative research data comes into play.
Qualitative data
Countless news and information sources report on companies and hot stocks. Some of them are freely available to anyone with a web browser (namely, just about everyone). Some are available only to subscribers. However, you get qualitative data, it’s an essential part of your research that many stockholders overlook.
When analysts look at different companies, they’re looking for answers to a few questions:
- What’s the company’s business model? Is it set up to continue generating revenue well into the future, or will it need upgrading or overhaul at some point?
- What’s the company’s value proposition? What products or services do they offer? What kinds of customers do they serve? Can customers only get the goods they want from that company, or can they get them from another company just as easily?
- Who are the people leading the company? What’s their track record? Is the leadership stable, or are managers frequently changing?
- Is the company scalable? Does it grow its customer base consistently? Can it manage the possibility of exponential growth?
- How do the company’s employees feel? Are they satisfied with their work? Do they approve of the CEO? Is morale high or low? Does the company have positive or negative notices on employer review sites like Glassdoor?
- What other companies, if any, does this business partner with?
- What were the most important events or benchmarks this company has experienced? What was its first success? What’s its biggest success? How well has it rebounded from economic downturns or recession?
These are just a few of the most pertinent questions to ask before investing in a company’s stock. There may be others that might be more important to you — ask those as well.
You might not be able to get all the answers to your satisfaction, or you may find out there aren’t a lot of right or wrong answers. But in combination with the hard numbers you get from your statistical research, this qualitative information gives you a fuller picture of the companies you’re considering for stock investments.
How do I find this data?
Several sources offer access to reams of financial and narrative data about companies with publicly-traded stocks. You’ll probably find plenty of them just by Googling the company’s stock ticker symbol, searching for articles and news reports.
Some of the more common, widely available sources for stock research include:
- Business media. Wall Street Journal, Investor’s Business Daily, and reputable stock-centric sites like Motley Fool and Seeking Alpha report both statistical info and news about stocks. Television business networks like CNBC and Fox Business cover breaking stories and general market analysis, but always have more comprehensive sources like WSJ at hand.
- Brokerage sites. Along with Gorilla, online brokerages and apps like Fidelity, E*Trade, Nerdwallet, and more offer thorough information about company fundamentals. Some include links to news sites right on the page for a given stock.
- Stock screeners. Sites like finviz.com, Yahoo! Finance, and many others allow users to search for and screen publicly traded stocks according to tons of criteria — business sector, company size, stock price range, annual revenue, price-to-earnings ratio, location, analyst recommendations, and much more. Screeners are great for finding potentially profitable small companies you’ve never heard of before.
- Company websites. Many companies post relevant financial news and information on their official websites. Keep in mind that these sites always put a company’s best face forward but may still have extremely valuable info like earnings statements and annual reports.
- Investment research centers. Organizations like Morningstar, Atom Finance, Zacks, and others guide potential investors to in-depth analyses of all investment opportunities, including stocks.
What a solid investment might have
There’s no single yardstick that measures a stock’s quality across the board. Healthcare companies have different standards for success than those who deal with consumer goods. Tech companies have different models than financial service firms. Even companies within general business sectors vary wildly from each other — biotech companies have different priorities than software manufacturers or cloud computing services.
But winning stocks typically have a few identifiable traits that make them favorable investments.
Solid fundamentals
You’re looking for companies that post consistent financial results: strong earnings, steady growth, robust sales. There’s a wide range of acceptable results in each category. Startups, for example, frequently post massive percentage annual revenue increases — say, 40% or more — especially if they’re still “small cap” companies that generate a fraction of the revenue blue-chip stocks make. For those larger companies, annual revenue growth of just 10% may be considered an excellent result.
Many investors stick to a policy of seeking companies with double-digit percentage increases year to year. That’s a fine place to start, but don’t stop your research there. Frame a company’s business results within the context of all the other information you learn.
Strong technicals
Technical analysis focuses on the price of shares in company stock. If a company’s doing well, its stock should show steady, dependable price increases over an extended time. It should also show a growing volume of stock transactions, individual events of buying and selling.
Technicals are different from fundamentals in that they address the results of a company’s business: its track record. Fundamentals are a direct evaluation of a company’s revenue, sales, assets, and liabilities. Both forms of analysis need to be used in conjunction to pick a stock to invest in.
Institutional ownership
When major investors — think BlackRock, Vanguard, JP Morgan Chase, or individuals like Warren Buffett — make sizable investments in a certain company, it’s usually a very good omen for that stock. Sources like Investor’s Business Daily track institutional investments show which companies are getting the most attention and experiencing the highest volumes of transactions by top-level investors.
One shortcut for finding companies that attract big-name investors is to scan exchange-traded funds (ETFs). These are investment “pools” that distribute stockholder revenues across several different companies. For example, a tech ETF may place its incoming stockholder funds in Apple, Microsoft, Amazon, NVIDIA, and dozens of other tech companies, large and small. An ETF may focus exclusively on small-cap companies, companies in a certain region, biotech or healthcare stocks — the possibilities are limitless.
If a stock you’re considering appears on the roster of multiple ETFs, it may be a smart choice to investigate. Look for ETF listings on brokerage sites or the funds’ homepages. You should be able to get a full list of all the companies every ETF holds. (Of course, you can also buy shares in an ETF yourself, often a very good idea.)
Healthy insider ownership
When a company’s financial records show that more employees are buying and owning its shares, it’s a sign that they have a high level of confidence in the company’s future — which is good because they’re in a prime position to make that judgment. Conversely, if a company’s stock profile shows a lot of insiders selling their stock, it’s usually not a good sign. (This kind of insider trading is legal and shouldn’t be confused with the illegal kind in which investors use privileged, non-public information to buy or unload stock.)
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