Most of us have a pretty linear definition of what makes a “good” company — useful products, strong sales, high profits.
But when it comes to investing in a company’s stock, potential shareholders look for a high rate of return on their capital. And that’s not always exclusively related to the basic service a company provides or how well they appear to be doing. Plenty of other factors, both visible and hidden, come into play.
Finding those gold-medal stocks takes a lot of careful analysis. There are a lot of considerations to make when determining where to invest money to get good returns.
The Stock Market
The stock market is probably the easiest investment vehicle to understand and explain. Companies and corporations offer shares in stock that virtually anyone can buy. In return, stockholders actually get partial ownership of the company. Just like the owner of a small or local business, stockholders realize profits when business is going well. And just as business owners invest on expanding their businesses, stockholders seek where to invest money to get good returns.
Investors trade for stock shares through a stock exchange, where thousands of companies put their shares up for sale. There are many stock exchanges throughout the world; the two most familiar ones in America are the New York Stock Exchange (NYSE) and NASDAQ. Most investor transactions with the stock exchange occur through brokerages; today, almost all stock trading is conducted on online brokerage sites.
The fundamentals of the stock market are fairly straightforward. Companies need to raise capital to fund operations and research that help them grow and expand. Stock buyers give companies that capital, with the understanding that they expect to share in the profits the company earns as a product of that growth.
Stockholders realize profits from their shares in two ways. The most basic way is that the value of their stock goes up. As that price increases, shareholders can sell all or part of their holdings to claim some revenue. Or they can leave their stock where it is, hoping to generate even more value over the long term.
Alternately, some companies reward their investors by paying out dividends. These payments, usually issued on a quarterly or annual basis, are simply distributions of a company’s net profits. Dividends can take the form of actual cash or additional stock shares. Many investors automatically reinvest their dividends in the company instead of getting the cash payout.
Words of Caution
Investors have two common priorities when deciding where to invest money to get good returns: generating profits and keeping their investments safe. These priorities aren’t mutually exclusive. Successful investors navigate the securities market and earn profits by balancing them both.
That said, even the most secure, dependable investments involve taking a risk. That’s just the nature of investing. Unforeseen events, sudden market changes, temporary trends, and business volatility are all part of the game. Investing is not quite as perilous as gambling — when you pay money toward an investment, you get something more than hope in return — but the same element of risk exists.
That’s why it is always beneficial for a new investor to decide how much risk they can tolerate. Low-risk investments are safer vehicles that won’t lose as much money but won’t generate as much revenue. High-risk investments can be instantly profitable, but their potential instability may be more than certain investors can stomach.
Fortunately, the investment market has room for those with various risk thresholds. It’s important to be mindful of the risk at all times, but it shouldn’t scare you off. An investment portfolio needs to be monitored, managed, and updated just like every other aspect of modern life — and there are plenty of resources that can help.
What Drives the Stock Market?
What are the fundamentals that have kept the stock exchange model around for hundreds of years?
Speculation is the biggest source of fuel for the stock market. Investment professionals make judgments on how successful certain public companies are likely to be in the future. Every stock market professional uses different methods and calculations to arrive at those decisions. Contrary to some cynical opinions, it’s not just guesswork.
Research is the most basic tool in evaluating a stock. Wise investors take close looks at every factor that contributes to a company’s overall value. Revenue and income are two of the factors researchers pay the most attention to, but they’re not the only indicators of a company’s potential. Comprehensive researchers also look at the company’s history, leadership, business plan, market share, marketing strategies, product development, and a host of other fundamental and technical aspects.
Investors use this data to evaluate the chances of a company maintaining long-term profitability. That’s not just a matter of making big profits in an abbreviated time — if that were true, Enron, Pan Am Airlines, and Blockbuster Video would still be around. Long-term sustainability also depends on innovation, how a company positions itself for markets that will emerge in the future. It also hinges on how leadership steers the company through challenging times (and, as we learned from the fall of Enron, whether they do so legally).
Stock market professionals also analyze factors that aren’t specific to one company. They evaluate the demand for a certain product and how companies supply it. They take a look at the overall economic and political environment that informs and shapes the market. Some even consider more intangible factors like “stock trader psychology” and “perception,” both of which can get pretty complex.
This just goes to prove that there are multiple approaches one can take when choosing a company to buy stock in. Whatever approach a would-be investor takes should be backed up by solid data and careful qualitative analysis — as objective and unemotional as possible.
Decide What Kind of Investor You Are
Knowing who you are is just as important as knowing the company you’re thinking of investing in. The stock market accommodates all types of traders: those who seek safe investments that generate consistent revenue, and more aggressive types who want to generate faster or greater revenue.
Conservative stock buyers gravitate toward proven, known entities with long track records of success. They’re usually household names — think Apple, Walmart, Kellogg’s, Nike, and so forth — that have weathered all the economic storms of the past and are staples of the international economy. Especially if they start investing at an early age, a conservative investor can leave their interest in one of these “blue-chip” companies and expect dependable, if unspectacular, returns over the years.
Other investors take a more aggressive philosophy — “go big or go home.” They seek to invest in companies still in their initial stages of existence, that are poised to make big gains in the future. Amazon was such a company; anyone who took a chance on them in the 1990s and stayed with them until now has realized incredible growth. But it’s not easy to find companies with that kind of potential, which makes this mode of trading riskier. Successful aggressive investors usually time their investments in up-and-coming companies, buying and selling at the precise points when they’ll best maximize their returns.
Both of these investment profiles are valid, as are those that mix or combine the two philosophies. There’s no right or wrong way to invest. What matters most is knowing what approach you want to take to from the investment strategy you need. It may (and probably should) change or refine itself as you gain more experience in the stock market. But to get started, it’s important to understand which kind of investor you are right now.
Some Metrics to Look For
Although the stock market is a versatile financial vehicle for both conservative and aggressive investors, it’s geared to long-term investments. The stock market’s “anchor tenants” — companies like Procter & Gamble, DuPont, 3M, Microsoft, Johnson & Johnson, and the like — are value stocks. They represent the old-school philosophy of leaving investments in one place for a long time, gradually drawing profits from dividends and occasional sell-offs.
But a short-term stock investment can be just as successful. Financing these investments may be risky, but that doesn’t mean they should be avoided altogether. With the right amount of research and deliberation, investing in these growth stocks can result in impressive and liquid capital gains. They can also serve as a hedge that protects your long-term investments.
While “good” stocks come in many shapes, forms, and kinds, there are a few fundamentals to look for in your research that may indicate where to invest money in order to get good returns:
Price-to-Earnings (P/E) Ratio. P/E ratio is one figure that stock investors consult the most. It measures a company’s value as a calculation of its overall market value divided by its earnings per share. For example, let’s say a company has 2,000,000 shares of stock selling for $40.00 per share. Let’s also say this company generated $8 million in profits last year, or a total of $4 per share. So, its price-to-earnings ratio is 10.0 ($40/$4).
Companies with relatively low P/E ratios may be undervaluing their stock price, which could indicate a good time to buy in before its value goes up. But in certain cases, companies with high P/E ratios could be positioned for quick and rapid growth, even though they’re risky. These variables are why the P/E ratio should only be considered in comparison with other factors to give a full portrait of any company.
Price-to-Earnings Growth (PEG) Ratio. This calculation takes the P/E ratio and divides it by the last rate of annual growth. If our company with a 10 P/E ratio grew by 8% last year, its PEG ratio is 1.25%. However, you can use a variety of growth calculations to produce the PEG ratio — last year’s growth, an average of several years’ growth, or projected future growth, for example — depending on what you’re evaluating.
A stock with a PEG ratio higher than 1.0 may be a little overvalued. One with a PEG ratio lower than 1.0 may be priced more fairly, or possibly too little. But again, the PEG ratio is just one factor to consider.
Dividend Yield. Not all stocks pay out dividends, but those that do offer an instant indication of their company’s fortunes. Along with how much a company’s dividend payouts are, investors look at the company’s history of dividend payments. If dividend payments are stopped for a time, it may indicate company instability. But a steady trend of consistent or increasing dividends may belong to a company worth investing in.
What a High-Return Stock Looks Like
Stocks that offer high returns are extremely rare. If you claim ownership in just one or two stocks, you’re in far better luck than most other investors. But most companies with solid returns on investment share a few commonalities.
Growth is the most obvious. A company that enjoys solid, consistently high growth numbers over a given time is likely a candidate for a good stock. Their balance sheet — which every person in the world can easily access — should reflect legitimate revenue generation through genuine services or products.
Although all companies need to innovate for future survival, the best ones have shown sustainability throughout their industry’s history. They’ve weathered all the economic recessions and downturns and remain viable. They make products and offer services that every human being needs at some point. They might even be a bit boring. But they’re dependable and consistent at turning profit.
Companies with these traits, more often than not, represent good stock investments — whether large or small, old or young, local or global. They’re not buoyed by instant, short-lived success. They’re cognizant and practical about maintaining a customer base, while always keeping an eye toward expanding their services in years to come.
Invest with Gorilla Trades for Good Returns
Gorilla Trades has a long history of finding both traditional and up-and-coming companies that produce surprisingly quick and profitable returns. We’d like to get to work on your portfolio. Get in touch with us to start a free trial.
