How to Pick Stocks: Everything You Need to Know As a Beginner
Stock market investments aren’t for the faint-hearted. One wrong move and you could lose it all; one right move and the jackpot is yours. As a beginner, this will serve as a guide on how to pick the right stocks?. But before venturing into the stock market ensure that you have set aside capital you wouldn't need for the next 5 years at a minimum. Stock prices take time to stabilize and are subject to uncertainty in their initial year's and a 20% drop isn’t an unusual thing.
Before Purchasing Stocks, Do Your Research
Researching before picking stocks will give you an idea of the investment if it's worth the risk. With thousands of companies to choose the stock from, it can be a never-ending process if you don’t use a targeted approach for stock selection. All industries don’t react similarly to one scenario across the world. Eg: During the onset of COVID-19 in 2019 where the Aviation sector was brought down to its knees. Some including the E-Commerce and cleaning industries flourished; since being at home and keeping clean was the top priority. Before moving on with how to pick stocks, analyzing industry strength at that time is key!
How to Pick a Stock: 9 Best Practices
Now that you’ve decided what industries and companies you’re interested in investing in, you can start working on the technique of picking stocks.
Determine Your Objectives
Objectives can be divided into 3 broad categories and each requires a different strategy to succeed. So as a beginner you should have a solid reason for which type of stock and industry you want to invest in?
Mainly there are 2 types of stocks:
- Common Stock - Shareholders hold the right to vote in shareholder meetings and receive dividends when paid.
- Preferred stock - Shareholders have limited or no voting rights in meetings. But reserve the right to receive higher dividend amounts and higher asset share in the event of liquidation.
Types of investors:
- A long-term investor who wants to acquire financial support during retirement.
- A low-risk investor whose main agenda is preserving their wealth and wants a safe investment opportunity such individuals invest their savings or retirement plans in mutual funds that specialize in sustainable investments (companies that strongly consider environmental, social, and corporate governance practices).
- A high-risk investor that’s looking to multiply his capital amount is willing to take the chance for gaining higher profits.
- Value Investors are also known as smart stock-pickers because they look for well-managed companies and ignore the market 99% of the time. A good example is Warren Buffet who invests in companies with low stock prices but have great success potential in the long run.
Focus On Key Elements
Now that you’ve decided what category of investors and shareholders you belong to next comes the complicated part, how to know what stocks to buy?. Looking through many financial statements can be mind-boggling but you can focus on the financial statements can be mind-boggling but you can focus on the fundamental factors listed below to look at the company's current and projected profitability.
- Positive earning trend - A small but consistent gain over the years is a positive indicator of the company's overall health along with its trending pattern and stability over the years.
- Operating margin – Higher margins generally reflect a smoother company operation.
- Cash flow Cash flow per share is one way to determine if the stock is undervalued or overvalued.
Pay Attention to Corporate Presentations
Making use of technical analysis – a trading discipline for evaluating investments and identifying trading opportunities in price trends and patterns that helps when searching for value stocks. Analysts believe that past trading activities and price changes of security can provide valuable insight into future price movements.
List of Publicly Traded Companies
For stock pricing directory Nasdaq's website is the most reliable source for stocks listed on the New York stock exchange, Nasdaq stock market, and OTC Bulletin. The directory also provides a corporate summary of the publicly listed stock trading companies, along with details like their market capitalization, symbol, and names.
Determine If a Firm has a Competitive Edge
According to Forbes, successful investors focus on a company's competitive advantage and not just profits. This is a crucial factor when deciding how to pick good stocks. Because it’s the company's competitive advantage that gears them to defend and scale their profits in the future. Other factors include competitor strategy and consumer behavior strategy. Analyzing these factors will help to determine if the firm has a strategic advantage against its competitors.
Determine a Fair Price for the Stock
The fair value of a stock is determined by the market value where the stock is traded, it’s the value of a company's assets against its liabilities rather than just the sale price. The 4 basic elements for an investor to break down a stock’s value are its
- Price to book (P/B ratio) - Compares a company's market value to its book value - the net assets of a company.
- Price to earnings (P/E ratio) - Helps analyze how well a stock price reflects the company's earnings, a key indicator to determine if the stock is undervalued or overvalued. With a preference towards higher P/E ratios.
- Price to earnings growth (PEG) - Used to define a stock's value while also factoring in the company's anticipated earnings growth, and it is thought to provide a more accurate picture than the P/E ratio.
- Dividend yield - Consistently paid off dividends translate stability, although unexpectedly high yields may mean the company is in desperate times wanting to retain investors and fetch new customers
When deciding how to select stocks to buy, having a portfolio dispersed across multiple financial instruments, industries and categories can be a great relief. Because it prevents risking the entire investment on a single stock. A diversified portfolio also gives a better analysis of how different instruments react to the same event along with generating profits. But analysts also suggest that it can’t guarantee against systematic or market risk but can mitigate the unsystematic risk. Especially since the investment is based on market news and a basic analysis of key elements.
Buy Stocks With a Margin of Safety
How to select a stock to buy is a daunting task for beginners due to being unfamiliar with stock market behavior. For this purpose Mutual funds turn out to be one of the safest investment instruments for generating wealth, achieving financial goals, and also come with tax benefits. While stocks are a single company investment, mutual funds are a group of investments with hundreds of stocks in a single fund. The other types are Exchange-Traded Funds (ETF) and low-cost index funds that are most suitable for beginners. As ETFs deliver the benefits without the added cost of an actively managed mutual fund that needs professional help. And to make it easy for beginners who are still learning about how to choose stocks; virtual platforms like the Wall Street Survivor - a stock market game provides guidance and $100,000 virtually to get you started.
Speaking of stock trading simulation, another platform that has been gaining massive popularity is Robo Advisor. Unlike the Wall Street Survivor, which is a brokerage that offers advice then automatically invests the client's assets based on the data provided by them, with minimal human intervention.
Decide How Long You Want to Hold the Stock
The stock holding time for a stock is one of the most important parts of your stock trading plan. How long to hold stock comes down to how much risk you're willing to take on and what kind of returns you need to be satisfied with your stock market investment.
The knowledge of how to pick stocks is only to guide you and does not guarantee success. Since high-profit margins and high dividend yields may not necessarily indicate a company's good financial health. The biggest example is Enron which gained favorable stock prices by manipulating future projections, but when their bubble burst it brought their stock price crashing down from $90.75 per share to below $1 in less than 18 months bringing the company to its knees. As a result, shareholders lost a shocking $74 billion accumulated over 4 years. Be smart, start slow, and start safely.