How to decide in which stock to invest

Beginners are usually confused with the complexity of stock trading and following market trends

How to decide in which stock to invest. Source: shutterstock.com

Investing opportunities seem attractive to many people. Making money work for you, instead of you working hard for money, sounds like a dream. In reality, beginners are quite confused with the complexity of stock trading and following market trends. The burden of decision-making shouldn’t be too heavy. Hence, here are some helpful tips on how to choose from the stock offers available.

How to choose a stock to invest in

Divide and conquer

Don’t put all your eggs in one basket. Try to make your portfolio diverse. Consider multiple sectors and industries. Combine various strategies: pick a few stable solid stocks and a range of startups with a promising growth scenario. That’s how you can increase the chances of getting dividends and lower your risks.

Check out the balance

Public companies regularly report their financial results. Don’t rely on the brand name or recognition only. Check the corporate balance sheet to ensure the company is not overloaded with debt. Does it have a healthy cash balance to cope with unexpected circumstances? If not, perhaps, it’s not the best choice in times of economic crisis.

Keep an eye out

If you decide to give investments a try, you’ll need to also keep track of the news. Source: shutterstock.com

If you decide to give investments a try, you’ll need to also keep track of the news. Economic and political changes may have a great influence over the stock market. Spot major global and national events. Moreover, rapid technological progress leaves behind even the most reputable institutions if they don’t adapt. Only those businesses able to find flexible solutions and tune in with the ever-changing needs will stay afloat. Keep your ears open to the news about separate brands too. That’s how you’ll be able to distinguish the prospective companies. Listen to and read the expert opinions, analyse the market trends, public demand, challenges, etc. That will help you make an informed decision. There are dedicated online tools to help you with this time-consuming task.

Check the share performance status

Before you invest, you can choose a few tradable shares and track their price for a while. Besides, pay attention to the most important performance indicators:

  • Earnings per share – show how much income the company generates per issued share. The result is assigned a rating of 1 to 99, with 99 being best. An EPS Rating of 99 indicates that a company’s profit growth has exceeded 99% of all publicly traded companies.
  • Price/Earnings ratio or P/E – lets you see how much of the share price is backed up by earnings. A high P/E ratio indicates that investors expect higher earnings because of growth predictions. However, it sometimes means that the stock is being overvalued. The average P/E for the S&P 500 has historically ranged from 13 to 15. A stock with a lower P/E ratio is typically regarded as being cheaper and may be underpriced in the short term.
  • Dividend yield – a measure of the cash flow you’re getting back for the money you’re investing. Generally speaking, a higher dividend yield is more attractive than a lower yield, because the yield reflects the types of returns that you earn. A good dividend yield will vary with interest rates and general market conditions, but typically a yield of 4 to 6 percent is considered quite good.
  • Return on equity – shows how well a company is making a return on their investments. A higher ROE is usually better while a falling ROE may indicate a less efficient usage of equity capital. The indicator depends on the industry. A normal ROE in the utility sector could be 10% or less. A technology or retail firm with smaller balance sheet accounts relative to net income may have normal ROE levels of 18% or more. Hence, you have to check the performance of a few successful competitors to know the average rate.

Be purposeful

While many shares may be worth investing, you compose the portfolio in regards to your financial goals. Perhaps, you wish to have additional savings for retirement. Maybe, you need to quickly raise some money for education. Or else, you just want to preserve the wealth you’ve already accumulated. It’s all individual. Remember, your goals determine investment strategies and tactics. Hence, set both short-term and long-term objectives.

Advice from experienced investors

Advice from experienced investors. Source: shutterstock.com

According to Warren Buffett, “When it’s raining gold, put out the bucket not the thimble.” When this legendary investor sees a good opportunity, he takes advantage of it to the foolest.

Bill Gross, the co-founder of PIMCO and manager of the PIMCO Total Return Fund, agrees: “Do you really like a particular stock? Put 10% or so of your portfolio on it. Make the idea count. Good [investment] ideas should not be diversified away into meaningless oblivion.

Moreover, Buffet stressed out that any investment opportunity must be understandable to a shareholder. He says that the rule of thumb is the ability to understand how the company makes money and the main drivers impacting its industry in less than 10 minutes. If it’s too complex for you, better move on to another business.

Benjamin Graham, the father of security analysis and value investing, suggested that every investor should clearly define their investment self. Active “enterprising” investors and passive “defensive” ones should choose completely different sets of shares for their portfolio. Therefore, if you’re ready to spend a lot of time researching the right shares, you may end up with higher returns. If you’re not willing to do much homework, stick to the safe side. You can get an average return by simply buying the 30 stocks of the Dow Jones Industrial Average in equal amounts.

And yet, as Peter Lynch said, “Never invest in any company before you’ve done the homework on the company’s earnings prospects, financial condition, competitive position, plans for expansion, and so forth.

Personally, I would add corporate mission and vision statements to this list. Anyway, don’t let the brand name only be your guide. Spend at least the minimum amount of time to get familiar with the company you’re going to invest in. Check both financial and ethical aspects. After all, as a shareholder, you’re partly responsible for its business development. Make sure that’s the kind of company you are willing to deal with.

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