What Makes a Good Stock Good?
A good stock appreciates in value over time. A good stock is one that has more value than more than it costs. If you don’t have a crystal ball, how do you figure it out?
The stock market is like a foreign language. You see all the information, but you’re not sure you understand it. The terms, the tickers – it’s hard to feel confident if you’re just starting. If you don’t know a good stock from a lousy stock can you really trust your money to a broker? Yes, you can, but paranoia is not an investment strategy. The smart thing to do is to learn.
Start by picking a company you’re familiar with – like Facebook or Pepsi or Home Depot. Google their name with stock market: Facebook stock market. Here’s what comes back in the Chrome browser:
This how Facebook is performing over one day, as of 1:15 on March 31st. The stock price is up by 7.74 points. ( If you look in the bottom right-hand corner, you see that the price per share at yesterday’s close was $288.) The abbreviation for Facebook on the NASDAQ exchange is FB.
There are 13 stock exchanges in the United States but the two most familiar are the NASDAQ and the NYSE. (Respectively, the National Association of Securities Dealers Automated Quotations and New York Stock Exchange.) Companies are typically registered on one or the other.
Before you spend $3000 on 10 shares of Facebook, do some basic research. Every company listed on a U.S. exchange is required to file financial reports with the Security and Exchange Commission (SEC.)
Form 10-Q: This form is required for each of the first 3 quarters of a company’s fiscal year. It includes unaudited financial statements that offer some insight into the company’s operations.
Form 10K: Unlike a quarterly report, this is an independently audited, annual report of key financial statements. Investors can get a look at sources of income, expenses, and revenue.
The SEC database is called EDGAR, you can find the link here with many other reports for researching investments. Every brokerage will have tools on their pages, some free and some premium.
Before you start looking at stocks, consider how much risk you’re willing to handle. The stock market is volatile. Stock prices go up and down. Over the long term, they go back up, but you have to ride it out. A risk profile is used to set up the assets in your portfolio.
Researching anything requires gathering pertinent information, then analyzing it. Stocks are no different. The only question – what’s pertinent. There are two schools of thought.
Technical Analysis: The price of stock is the first thing most investors check. Technical analysts use price as the foundation of their research. The premise is that a share price reflects market trends. As a result, analysis of the stock’s price history should predict its future value. This is what all the talk of “moving averages” is about.
Fundamental Analysis: This methodology goes beyond the quoted stock price. These analysts look at the business itself, operations, executive salary, ethics, and practices. The goal is to determine whether or not the current price of a stock is attractive. Fundamental analysis is designed to get in early and hold for the long-term.
Read: (How to Start Investing)
Choosing Stocks on Your Own
Research is a process. There is a lot of information to be assessed when looking at a stock. Keep it simple or it’s easy to end up down a rabbit hole. Choose trusted sources for information. Do not just take “stock tips” from all the folks who want to give them to you. If you want to start buying good stocks – do the work.
The way to create wealth is to buy at a good price and hold the stock for the long term.
1. Go with what you know
Choosing a stock means choosing a company. If you like a particular product or service, start there. If you always shop at Home Depot or can’t drink enough Diet Pepsi, consider using them to start your research. It’s good to have some inside knowledge and it’s less intimidating for new investors too.
It doesn’t mean that everyone likes Home Depot as much as you do, but it gives you a familiar starting point. You’re not flying blind.
2. What industry?
When you look at a company, the industry has bearing on its value. As a result of the pandemic, certain industries were hit harder than others. Share prices for companies in the travel industry plummeted. Hotels and hospitality venues that rely on gatherings took a hit as well. Conversely, companies that delivered online communication services, like Zoom, soared in value.
No company can predict a catastrophic event like COVID, but you can look at how they respond to it. You can use companies hit hard during a recession. In 2008, that would be mortgage providers, investment bankers, and automobile manufacturers. If you do a technical analysis, there is clear evidence of how long it took to rebound.
There is also a big difference between an industry startup and an existing company. There is a lot less information on a startup. Despite a high initial price for the IPO, demand for the product or service is still unproven.
3. Look deeper at the company
Once you’ve chosen a possible stock purchase, it’s time to look inside the company. Their annual report will have the financials but there are other questions to be answered.
- Who is running the firm? Take a look at the leadership team – what’s their approach? Who’s on the board of directors? The board represents the shareholder’s interests. The composition should be independent enough to push back when needed.
- Does the company have cash on hand? When trouble hits, companies with liquid assets have more options. As the pandemic proves, things can go wrong. Having access to cash can be critical.
- Compare the company’s performance to their competitors. Do they have an advantage?
- What is their primary source of income? Don’t make assumptions. In 2019, Mcdonald’s made $11.66 billion by selling franchises, as opposed to hamburgers.
- Are there big changes ahead for operations? If a large contract is ending or a patent is expiring, there can be significant shifts in revenue. Investigations by regulatory agencies or lawsuits will hurt the bottom line and the brand overall.
4. Check the Sec Database
The SEC database –EDGAR (Electronic Data Gathering, Analysis, and Retrieval system) has tons of information. Before you query, give some thought to what you’re looking for. There are annual reports, quarterly filings, sometimes there are press releases about changes in company policy. You can search by company name, but can also look for specific works, like salary, dividend, etc.
Here’s one other tool that can save you some pain. If you are considering an investment broker, get a look at his or her background on investor.gov. The resources on this site include alerts on scams, reporting fraud, and investment calculators.
5. Look at Price-to-Earnings
Price to earnings ratio (P/E) is a calculation that measures the market value of a stock and compares it to the company’s earnings. To calculate the P/E ratio, divide the current market price of a share by the reported earnings per share.
The current market price of a share is the total market value of the business divided by the number of shares outstanding. Earnings per share is the company’s net profit divided by the number of outstanding shares.
Once you have those numbers, you get a better look at how the business is doing. The higher the P/E ratio, the more attractive the stock appears, at least on paper. You can compare the P/E ratio to other companies in the same industry.
Price to earnings growth ratio (PEG) looks at the rate of a company’s growth. The calculation uses a stock’s P/E ratio and divides it by the projected annualized earnings growth rate. Calculate the annual growth rate by dividing the growth at the beginning of a year by the growth at the end of the year. The faster a company grows, the faster you see a return.
Just remember these calculations are based on historical numbers. There is no guarantee they will play out the way you projected. They are just pieces of information that should be factored into your analysis.
6. Pay Attention to the News
Not everything you need to know about a company comes from a prospectus or annual report. Your research needs to be current – as in current events. Considering stock in companies that manufacture aircraft? Set up a news alert on plane crashes. Most major companies are global. When a cargo ship blocks the Suez Canal for a week – there are going to be supply chain issues for a lot of companies.
If you’re researching to buy or have already bought, these events can be extremely important. Many times, these events are temporary, but they cause a drop in share price. The value of the company hasn’t changed but the price of the stock has. It can be an excellent time to buy, given the scope of the incident, litigation, or penalties.
7. Review Analyst Expectations
Every quarter, publicly-traded companies in the U.S. report on their finances, as required by law. Financial analysts make predictions on what the numbers will be. It can be helpful to see what they’re saying. Before you start any actual buying, choose 2 or 3 analysts to follow. A consistently accurate analyst should be considered a good resource.
A good stock should meet or exceed analyst expectations. If you’re getting ready to buy, this is a good metric for investing.
Warren Buffet once said, “Never invest in a business you cannot understand.”
When you buy stock, you become part-owner of a business. If you don’t have a clue about blockchain technology, cryptocurrency stocks probably aren’t for you. Learning to understand a stock’s value is the foundational purpose of research.
Value and price are the not same thing. Price is how much you’re charged, and value is how much something’s worth. Once you get past all the acronyms and tickers – ultimately a stock purchase is an investment in a company. Choosing that company has a lot more to do with its value than it does with the price of a share.
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