Picking the right stock is a crucial step when it comes to investing in the stock market. The stock you invest in will determine whether you are going to gain or lose money in the future. Sometimes, a stock might seem the perfect one at a particular moment, but it turns out to be a loser in the new few weeks or year. Alternatively, maybe you didn’t put high hopes and a lot of interest in a specific stock, but you end up regretting it when it turns out to be a winner stock.
The stock market has never been a game of luck and will never be. To make the best out of the stock market, you need to adopt an excellent investment strategy, which involves picking the right stock at the right time that will help you generate high profits in the future.
If you are a stock investor, or just getting started in the stock market and want to know how to pick the right stock, you can start with this guide. You will find all the dos and don’ts when choosing a stock.
What to Do When Choosing a Stock
Buy what you know
As a general rule, it is very beneficial to start with a company or industry you are familiar with, for many reasons. The more you know about a particular company or industry, the more your head is in the game. For instance, if you are in the medical field, you will more likely have a better idea which pharmaceutical companies are on top of the industry and how effective they are in terms of customer service and sales. Also, bear in mind that any nonpublic information you receive in an official capacity might be considered insider information. But still, any public information that is not widely spread can give you a significant advantage.
On the other hand, make sure to avoid the hype because you might end up losing money when these emerging companies turn out to be losers. Many investors fall into the trap of buying a stock that they don’t fully understand, and just because a particular industry went viral at that time, which might not last for long periods.
Consider price and valuation
Expert investors often look for individual stocks that are “undervalued” or “cheap.” This generally means that the different investors are paying a fairly low price for every dollar a company earns. It is measured by the price-to-earnings ratio (P/E) of a stock price. (it is the share price of a company divided by its net income). When comparing the P/E ratio results, a stock price is considered cheap when it is below 15 and expensive when it is above 20. But still, there is more to consider:
- Expensive doesn’t necessarily mean bad, and cheap doesn’t necessarily mean good. Sometimes, the reason behind the low price of a stock is that the company is slowing down or growing less. Alternatively, a stock is expensive sometimes because it is predicted that the company is going to overgrow in the coming few years. So, if you want to buy a stock that will more likely be worth a lot later, look at the value combined with predictions for future earnings.
- Know your stock. Generally, a company that is expected to grow significantly and rapidly in the near future will more likely be more expensive than an established company with a slower growth rate. Before locking your choice, make sure to compare the P/E ratio of a particular company with the P/E ratio its competitors of the same industry and check whether it is more expensive or cheaper than its peers.
Analyze the financial health
It is essential to have an in-depth analysis of the financial reports of a particular company you are interested in. Besides, it is easy to find these reports since most of the public companies tend to release them quarterly and annually. Make sure to check the Investor Relations section in the company’s website, or look for official reports listed in the SEC online. To make your research even more efficient, don’t just focus on the most recent releases. Instead, put more emphasis on a solid track record with a consistent history of financial health and profitability, for long periods.
- Look for revenue growth. Stock prices tend to significantly increase when companies are generating more money in the long term, which typically begins with growing revenue. Analysts usually refer to revenue as the “top line.”
- Check profit margin. The profit margin of a company is the difference between its revenue and expenses. Generally, a company tends to expand its margins when it is growing revenue while successfully controlling costs.
- Get to know how much debt the company has. To do so, make sure to check the balance sheet of the company. A company with more debt generally have a more volatile share price because more of its income has to go to the debt payments and interest. Also, check whether a company is borrowing an unusual amount of money from its group peers for its industry. That would positively affect its price share in the short and long-term.
- Find a dividend. A dividend is an amount of money paid regularly by a company to its shareholders, and it is a sign that a company is in an excellent financial health. Make sure to look at the history of their dividend payments, whether they are increasing or not.
What NOT to Do When Choosing a Stock:
- Don’t rely on price alone. Just because the price of a stock has dipped 10%, doesn’t mean that it is a bargain and you should buy it right away. It is very important to know the reasons behind its fallout and have a better understanding it is going to rebound.
- Don’t count a lot on analyst recommendations. It is always a good idea to listen to the experts’ advice. They can provide you with valuable information about the health of the business. However, be cautious that they tend to favor ‘buy’ ratings. That is why a sell rating, especially a new one, might be a red flag from an analyst perspective. You should always keep an open eye on those calls
- Don’t neglect the stocks’ volatility. Compared to a diversified mutual fund, an individual stock tends to be more volatile. So, make sure to check the stock’ highs and low within every week of the year to have a better idea of how the prices swing all year round.
- Don’t forget to sell. You should always have a solid strategy when investing in stocks. You need to know when to buy a particular stock as well as when to sell it. To do so, make sure to set some criteria to know when is the right time to sell that stock: if the price goes high or down to a certain point if the particular company cuts its dividend, if an analyst depreciates the stock, etc. This will undoubtedly help you better manage your stocks and avoid rushing to selling over a short-term fluctuation in the market. When following these criteria, you increase your chances of success and minimize the risk of losing your stocks during unexpected events.