Buying and selling stocks is an easy task – you can find clear instructions on your favorite online stock broker on how to properly use their trading platform. However, if you want to yield higher rewards in the long term, you need to learn all the fundamentals of stock investing – how to pick the right stocks that can generate high profits in the stock market.
In this article, you will find all the necessary information on how to buy stocks. Here’s all that you need to know:
1. Getting to Know How Stocks Make Money
When purchasing a company’s stock, you are buying an ownership share in that particular company. In fact, there are two ways to generate profits from stock investment. First, you can hold onto your shares and benefit from the dividends, which are the portion of the earnings of a company distributed to the different shareholders.
Typically, dividends are distributed quarterly, which makes it a great way to gain a steady stream of profits. Second, you can sell your shares for a higher price than their initial one. For instance, you can purchase 100 shares of a company’s stock at $10 per share. Then, the price rises to $15 per share during the next several months. By that time, you can sell all your shares at a higher price and make $500 of profit on the sale.
2. Long-term Thinking is the Key to Success
Many investors get into the stock market business in the hopes of gaining high profits within a short period. However, the truth is that generating high revenues in the stock market is a slow process which requires a lot of patience and persistence. That’s why you need to adopt a long-term strategy when investing in individual stocks. It is quite simple: look for great companies to invest in, then hold onto the stocks for longer periods.
3. Look to companies you understand
As long as you are familiar with the company and have a good understanding of how it makes money, you won’t have a hard time determining whether you should buy its stock or not. For instance, if you are more into the technology industry and you have enough knowledge about it, it would be easier to compare two smartphone companies and decide which one you should invest in. But still, you need to do additional researches before buying up shares to further increase your chances of success.
4. Pick Companies with a Competitive Advantage
When it comes to buying individual stocks, you need to pick the right companies. Besides, it tends to be riskier than buying index funds or mutual shares, yet it can generate higher revenues. When looking for potential companies, you should look for some particular components that determine whether a specific company is successful or not.
Competitive advantage is one of these characteristics. It is basically a leg up over similar companies. The more sustainable competitive advantage of a particular company is, the more likely it is to keep growing and generating higher profits in the long term.
For instance, Amazon.com (NASDAQ: AMZN) is one of the most popular companies with a sustainable competitive advantage. Its cost-effective and strategic warehouse setup, as well as its essential relationships with couriers, are the key features that allowed the company to maximize profits and optimize efficiency. Even more, Amazon.com has its army of robots to facilitate the process of fast shipping.
5. Look for Companies with Solid Management
Having a strong management team is a key feature that determines the success and prosperity of the company. They are responsible for making critical decisions that will influence the companies’ values over time. So, it is highly recommended to find companies with excellent and reliable leadership teams. During your search for your next potential companies to invest in, make sure to check if the managers have a strong track record, specific talents, and ample experience.
6. Recognize Growth Avenues
You need to pick the right companies that provide the best growth opportunities if you are willing to invest in the long term. Growth investors are interested in companies that are anticipated to accelerate at a faster rate than their rivals, and that generate above-average profits. However, growth avenues can take different forms and shapes. So, when you are analyzing different companies, make sure to understand where they are going in the near and far future; not just how they are currently doing.
For instance, since its initial launch, Amazon.com has continuously branched out. It started as a web-based bookseller, and it has been evolving ever since. Now it sells all sorts of products, from apparel to groceries. So, it is easy to see how it may continue growing to dominate new corners of the market over the years.
7. Tune in to Recent Conference Calls
If you want to learn more about the company of your interest, you should tune in to the earnings conference calls. Typically, companies perform conference calls quarterly, usually right after the release of financial information.
You will find valuable information about any particular companies during these conference calls: the latest financials discussed by the management, major factors that influenced the performance, and estimations for the next quarter or year. Besides, you will have a better understanding of how the company’s management copes with the different changes in the performance, for better or worse.
It is quite possible for a specific company to have high profits for one quarter and low profits the next. But still, the way the management handles these changes can have a big influence on the long-term viability and value of the company. Also, in most cases, you can find the conference call schedules on the company’s website, and everyone can listen to it online.
8. Determine the Value of the Stocks
As a stock investor, you need to figure out the value of your different stocks, and whether the trading price is fair. To have a better understanding of the different values of your stocks, there are simple formulas and tools you can use.
Typically, companies are valued based on their revenues and earnings per share (EPS) – which is the portion of the profit of a particular company allocated to each share of common stock.
Alternatively, you can use the price-earnings ratio (P/E ratio) to measure the value of any specific company. It measures the current share price of a company relative to its EPS. As a simple formula, it is calculated by dividing the stock price per share of a particular company by its EPS.
Generally, a company with a high P/E ratio is anticipated to have strong future growth. However, having a high P/E ratio doesn’t necessarily mean that the company is overvalued, and a low P/E ratio doesn’t necessarily mean that the company is undervalued. Besides, the P/E ratio is very helpful when comparing companies of the same industry.
9. Start Small and Diversify
With experience, you will be able to spot very rewarding stocks with high potential for great revenues. But still, every great stock comes with a certain risk level, generally higher risks than any other average-revenue stocks. That’s why you should never put all your money in one individual stock, even if it has 100% chance of success. I believe that you don’t want to lose all your money if anything unexpected happens. Even the highest companies face harsh times from time to time.
Additionally, once you have identified a great company with a potentially high revenue to invest in, it is best to start by purchasing a quite small position of its stock. That would undoubtedly minimize your risks of losing. Moreover, make sure to diversify your portfolio to increase your chances of success further while keeping a low-risk level. Besides, when buying stocks from different industries, you significantly lower the possibility of losing a considerable sum of money when a particular sector fails.
10. Keep Track of Your Investments
It is natural to keep track of your investments once you are done with buying your stocks. However, you shouldn’t keep checking them all the time, every day. That would turn you crazy and even lose your temper, especially when you don’t notice any significant changes from day to day.
As long as you are willing to invest in the long term, you don’t necessarily need to follow up on your investments very often and within short periods. Due to many factors, it is totally normal that a stock price fluctuates a lot.
With that being said, checking your investments once a month would be enough to see how they are doing. In addition, make sure to check up on the invested businesses and search for any potential red flags. For instance, if they are planning on changing the manager, and that doesn’t make you feel comfortable, you may want to pull out instead of taking your chances.