Buying stocks can be a gamble. The potential for winnings is absolutely unlimited and your potential for loss has a nice solid barrier: 100% of whatever you put into it. Unless you decide to play the shorting game, in which case your losses are potentially unlimited too.
But that’s the fun, right?. . Maybe not.
But whatever your interest in purchasing stocks, what’s pretty straightforward is that if you want to improve your chances of betting on a winner and win at stocks, you have to do your research.
We’ve covered your bet there — here are the secrets to make you savvy in researching your potential stock portfolio selections.
There are two major types of investigations you can perform when checking out stocks. It’s a great idea to spend some time learning both types because, while different, they each have their own purposes that can help you choose a stock that fits your investing style.
Technical analysis is a stock performance-based research method. This means if you are engaged in this type of analysis, you are watching past stock price movements and looking for patterns and trends to help you predict when a stock is going to get hot so you can capitalize on it.
In this particular article, we are more concerned with fundamental analysis. This method involves digging deep into the company itself to determine whether it is a solid investment for future growth.
Some features that someone interested in the fundamentals will investigate are the company’s financial and asset situation, their leadership group, and how they stack up to their competition, among other inner business workings.
The bottom line is determining whether or not the company is in a strong position to grow rather than bleeding out their resources.
The Fundamental Four
Before we get into the nitty-gritty, it’s important to understand a few concepts. First off, you need to know your end-goal. Are you looking for long-term growth investment? Maybe you’d rather earn income by creating a portfolio of dividend earning stocks. Or perhaps you want to play fast and loose and seek the big hit.
That latter idea is actually not investing, it’s a technique called “speculating” and it’s a high risk maneuver not recommended for beginners. Besides, that form is usually more interested in technical analysis than the fundamentals we are studying here.
Keep your investment end goal in mind; we’re going to keep this as simple as possible.
Here are four steps you can take to prepare your fundamental research enough to make a firm evaluation on whether you should invest in a company or give it a pass.
1 – Collect Your Research
One of the most important documents that you will want to consider is the company’s annual report (Form 10-K). This document can be found on the website of the company in question and other locations as it is a public document; it won’t be hard to find.
The annual report shows how the company did in the most recent year, providing all of its relevant information. Therefore, it’s a great tool to see exactly how the company is performing.
Form 10-Q is the quarterly report, so it breaks that information down so you can see which direction the company is moving — growth or loss.
2 – Focus On the Big Numbers
These are some concepts you need to consider when you’re trying to decide how these numbers determine how a company is doing during your analysis of the above reports.
This idea is a simple one: revenue is how much money the company is bringing in. You would think if they’re bringing in a lot of money, they’re doing well, right? Well, maybe. That depends on a few more aspects before we can make that determination.
This number right here is a big one. It’s how we use that revenue above with a few other factors to find out if the company is actually making any money.
Net income is how much actual profit the company is making. Revenues minus expenses equals net income. The expenses are located on the annual report, too, so if you do this basic math you can see if you have a profit (positive number) or a loss (negative number).
Look carefully into all net income information available to common stockholders. Obviously, you want to see a positive number if you’re thinking of buying into this company.
These three factors are also important considerations.
- Earnings Per Share – This tells you the company’s profit based on individual shares of stock.
- Price-to-Earnings Ratio – This may be the largest factor when reducing risk. This ratio takes the current stock price and divides it by the earnings per share.
- Lower risk options have a P/E of close to 1.
- Stocks with the highest P/E ratio are volatile and probably overvalued (high risk!).
- A missing P/E is a red flag because it could mean that the company is not actually making a profit at all!
- Return on Equity- Company profit generated per each dollar invested. You can find a return on common stockholders equity calculator online to help you see how much a company makes based on invested money.
- Return on Assets – Profit made by using the company’s money.
3 – Company Analysis
Now that you know the basics on how to read the most important numbers, it’s time to look at how the company itself works.
Figure out what the company does to make money. If the explanation doesn’t make sense to you, it’s probably better that you choose a company with a more concrete method.
Is the company innovative? Does it stand out from its competitors? These are important questions to ask because it’s an important survival trait.
Is the company run by a competent management team? Find out! Solid leaders make solid investments. If weak or incompetent leaders are steering the ship, it’s probably heading for a crash.
Seek out red flags. Are there scenarios that could arise to cause the company to struggle? Have they taken large risks or taken on large debts that may not pay off in revenue?
4 – Flashback
If you want to gauge the company’s future, research its past. It’s important to contextualize the annual numbers by looking back beyond the recent year and even as far back as the company has existed if possible. Trends should be apparent, especially whether the company is growing or stagnating.
For example, the annual numbers may look promising, but if you look back at previous years, you may notice that for the company, it is actually a steady decline.
Take this into consideration before you make a final decision on a purchase.
Helpful Tips to Win At Stocks
Evaluate carefully before making a big decision. If you are still struggling to understand how the numbers compute (which is understandable), consider consulting with a financial advisor who can help break it down for you.
Otherwise, there are many online resources available to you that dig into each concept in depth.
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