Stocks, or equities, are shares of ownership in a company. Investing in the stock market by purchasing these shares can be a great way to grow your money for the future.
But how much money you make – or lose – largely depends on the stocks you pick. So how do you know which stocks to invest in for long-term growth?
We’ll give step-by-step pointers on researching stocks like a wall street pro. We’ll also let you know what data to pay attention to and how to consider your risk tolerance and goals to guide your investment decisions.
Then, even if you’ve never invested in the stock market, whether you have a small amount of money or a windfall, you can start researching stocks to add to your investment portfolio.
Why Invest in Stocks?
People invest in stocks to make money, primarily by selling the stock if its value increases. But investors can also make money with stock dividends, which are a company’s earnings paid to shareholders.
Historically, the stock market offers more significant growth potential than most other investment types. But “potential” is never a guarantee. There are substantial risks to investing in stocks. You could lose some or all of the money you invested in the stock market.
Invest for long-term growth
Because of the risk of investing in stocks; they tend to be best for long-term investing. Stock prices can rise and fall in a short amount of time. Having a longer investment timeline (at least five years), as opposed to shorter timelines, like a year, a few months, or even a day, helps to mitigate the risk of a stock’s short-term volatility (fluctuations in value).
How Can I Start Investing in Stocks?
Starting to invest in stocks is easy, in theory. All you need is some money to invest and a brokerage account, such as an online investing app or – if you’re investing for retirement – an account like a 401(k) or individual retirement account (IRA).
However, investing is more than setting up an online stock trading account and throwing darts at a board to pick stocks. To find the right stocks to invest in, you’ll need to know your budget, risk tolerance, investment goals, and which stock data to consider.
Before you research the data, here are some clever things you can do to prepare to invest in stocks:
Define your risk tolerance
Does the thought of losing money make you anxious? Or are you okay with losing the money you’re investing? Defining your risk tolerance – often described as either aggressive, moderate, or conservative – will help you choose stocks, so you stay within your investing comfort zone.
Make an investment budget
Along with defining your risk tolerance; you’ll want to establish your risk capacity, which is the amount of money you can reasonably afford to lose.
This will help you figure out how much to invest and at what intervals. For instance, will you invest a lump-sum of $1,000 into a brokerage account once or contribute $100 biweekly from each paycheck, as you might with a 401(k)?
Establish a timeline and goals
Consider your investment goals and how long you have to accomplish them. You may have a goal of buying a house in 5 years or a 15-year plan of saving for a child’s education. Because plans can change during your life, it’s important to revisit them regularly to ensure they’re still appropriate.
Open an investing account
You can choose to set up a brokerage account at an investment firm. Some banks and credit unions also offer investment services.
You can start investing in stocks in minutes with an online brokerage account. Many of these online brokers feature “robo-advisors,” but some offer individual investment advice like a full-service investment firm.
An IRA is another option if your investment goal is to save for retirement.
How to Research Stocks in 4 Steps
Researching stocks is a way to predict a stock’s future performance and decide if it fits your investing needs.
There are two main types of stock research:
- Fundamental analysis: This uses a stock’s financial data.
- Technical analysis: This uses patterns in the stock market and past stock prices.
For the most part, investors researching an individual stock tend to focus on fundamental analysis, which looks at a range of aspects of the company, the industry, and markets as a whole.
This analysis will help you find stocks you’re interested in and rule out the stocks you don’t want.
Here are the steps to researching stocks:
Step 1: Gather company financial documents
Publicly traded companies in the U.S. must make many of their financial documents public, according to the Securities and Exchange Commission (SEC). This makes it easier for investors to evaluate a company’s stock.
The three main reports needed to research a company’s financial health are:
- Form 10-K: This annual form contains financial statements that outline valuable data for anyone researching stocks, including the company’s revenue, cash flow, assets, and liabilities.
The 10-K is audited by a third party and can be accessed from the Electronic Data Gathering Analysis and Retrieval System (EDGAR) on the SEC’s website. You can search for the documents by company name, exchange ticker symbol, and other information.
- Form 10-Q: The 10-Q contains much of the same information as the 10-K, but it’s released quarterly, and the data is unaudited.
This form can also be accessed using the EDGAR on the SEC’s website.
- Annual report: This document is often printed into a book with a letter from the CEO and highlights of the company’s activities. Although financial data in the annual report isn’t as comprehensive as the 10-K or 10-Q, it tends to be presented in an easy-to-understand format.
The annual report is usually found on the company’s website.
Step 2: Narrow your focus (quantitative research)
Honing in on specific financial data (doing quantitative analysis) will help you evaluate a stock with more clarity. This data includes:
Which is the company’s total gross income. It’s usually described in two ways. Operating revenue is income the company brings in during day-to-day business activities. Non-operating revenue is income generated from a unique activity.
You can use a company’s revenue to determine its worth, see if it’s growing, and compare the revenue to earnings and share price.
Net income (earnings)
Net income, or the “bottom line,” is a company’s income (or profit) after accounting for business expenses like payroll, taxes, and operating expenses. Strong earnings can be a good sign that the company itself is strong.
Earnings per share (EPS)
Dividing a company’s earnings by its outstanding number of shares will give you the EPS. This shows investors a company’s profitability per share. It’s often used to compare one stock to another. Generally, the higher the EPS, the better.
Price-to-earnings (P/E) ratio
By dividing a stock’s share price by a company’s earnings per share, you get the P/E ratio. With this number, an investor can evaluate a stock’s valuation – whether a stock might be a good value (low P/E ratio) or is overvalued (high P/E ratio).
To judge whether a P/E ratio is low or high is somewhat arbitrary. But some investors consider a P/E ratio below 15 to be low and 20 or higher as high.
Price-to-book (P/B) ratio
The P/B ratio compares a stock’s market value with the book value on the balance sheet. Typically, investors look for a company’s P/B ratio to be less than 1.
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. The debt-to-EBITDA ratio tells investors how well the company pays off its debts. In general, the lower this number, the better. Some investors consider anything over 3 to be a red flag.
Return on equity (ROE) and return on assets (ROA)
Both of these metrics tell investors about a company’s profit. ROE shows how much profit the company generates from each dollar of shareholder equity. ROA shows a company’s profitability after assets and debt allocation.
An ROE of around 15% – 20% is typically considered good. A strong ROA is generally considered 20% or higher, but some investors judge anything above 5% as acceptable.
Step 3: Conduct qualitative stock research
Qualitative research involves looking at a company’s non-quantifiable information, also known as soft data. Some questions qualitative analysis can answer about a company might include:
- How does the business make money?
- How big/strong is the company’s competitive advantage (how wide is its “moat”)?
- How much experience does management have, and what is management’s track record?
- What can threaten the company’s growth? What are the potential risks?
- What are the company’s values?
Qualitative research is challenging to measure. But if you understand and can explain what a company sells, its products, business philosophy, and management, and think its growth prospects outweigh its risks, these are all positive signs.
Step 4: Decide if the stock is right for you
Now, go back to your tolerance and goals. The suitable investments for you will fit into your investment strategy.
You might consider a growth investment strategy if you’re young and have aggressive risk tolerance. You’ll probably want to focus on growth stocks that may expose you to more risk but potentially have a more considerable upside.
If you consider yourself a bargain shopper, you may want to adopt a value investment strategy. You might consider stocks you think have a higher intrinsic value than market value – this is, based on your analysis, you believe the stock is worth more than its current market price.
You’ll want to avoid riskier investments if you have more conservative risk tolerance. One way to do this is to focus on blue-chip stocks (those from established companies with dependable returns and less risk) for your portfolio.
Online stock screening tools
You can get help finding the right stocks to invest in by using online research tools. Some brokerage companies offer educational and evaluation tools on their websites for individual investors. And there are free stock screeners online that are easy to use.
Take Stock of The Company and Your Goals
Whatever your goals are, remember that diversification is key to investment success. Be sure you’re considering individual stocks as just one part of a diversified mix of investments, and know that there’s no one “best stock” to add to your portfolio.
It’s always a good idea to seek the help of a financial professional for guidance in formulating a strategy that’s right for you. They can help you find the investments that are most likely to fulfill your goals.