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How to Pick Stocks: 14 Things All Beginner Investors Should Know

by Lily Morgen
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Stock investing for beginners

When you decide to buy a stock, you are buying a piece of a company that will be worth more in the future than it is today. But how do you know which stocks to buy, and when?

There are a lot of factors to consider when picking stocks, but don’t worry – we’re here to help. In this article, we’ll go over some of the basics of choosing stocks as an investment, including how to research and assess a company, and what to look for in terms of growth potential.

1. Short Term or Long Term

The first thing you need to decide is whether you want to buy stocks for the short term or the long term. Short-term investors generally buy stocks with the intention of selling them within a year or less, while long-term investors may hold onto their stocks for several years.

There are pros and cons to both approaches. Short-term investors can take advantage of market fluctuations to make a quick profit, but they also face the risk of losing money if the stock price falls. Long-term investors may not see the same level of immediate gain, but their stocks have more time to grow in value, and they’re less likely to suffer from short-term market volatility.

Ultimately, the best approach for you will depend on your investment goals and risk tolerance. If you’re just starting out, you may want to take a long-term approach so you can get comfortable with the stock market before trying to make quick profits.

2. Investment Strategy

Once you’ve decided whether to take a short-term or long-term approach, you need to develop an investment strategy. This will help you select the right stocks to buy, and also when to buy and sell them.

There are many different investment strategies out there, but some common approaches include:

Growth Investing

This strategy involves buying stocks in companies that are growing rapidly. These companies may be young and unproven, but they offer the potential for high returns.

Value Investing

Value investing focuses on buying stocks that are undervalued by the market. These stocks may not be growing as quickly as growth stocks, but they’re usually less risky and can still offer good returns.

Dividend Investing

Dividend investing means buying stocks in companies that pay regular dividends. These stocks can provide a steadier return than growth or value stocks, and the dividends can provide income even when the stock price is not rising.

Trend investing

Trend investing strategy follows market trends and buys stocks that are rising in price. This can be a more speculative approach, but it can also lead to quick profits if you buy at the right time.

Your investment strategy will depend on your preference at the moment. It may change after you have much knowledge and experience in the stock market. 

Growth stocks may be more volatile, but they offer the potential for higher returns. Value stocks may be less risky, but they may not offer the same growth potential. 

Dividend stocks can provide a steadier return, but they may not offer as much income as other types of stocks. It may be hard to make money in trend stocks as it almost has no logic to follow, but if you are lucky enough to pick the right stock at the right time it can be profitable.

3. Learn Some Important Ratios

Once you’ve realized which investment strategy is more appropriate for you, it’s time to start researching individual stocks. When you’re looking at a stock, there are a few key ratios you should pay attention to:

Price-to-earnings ratio (P/E ratio)

When it comes to stocks, PE is an important metric to consider. PE, or price-to-earnings ratio, is a measure of how much investors are willing to pay for each dollar of a company’s earnings. A high PE ratio indicates that investors are willing to pay a premium for the stock, while a low PE ratio indicates that the stock is relatively inexpensive.

One important thing to keep in mind when considering PE ratios is that they can vary widely depending on the industry. For example, a company in a high-growth industry like technology will typically have a higher PE ratio than a company in a more mature industry like manufacturing. This is because investors are willing to pay more for a company’s earnings when there is the potential for strong future growth.

When evaluating a stock, it is important to consider its PE ratio in the context of its industry and other companies in its peer group. This will give you a better idea of whether the stock is truly expensive or not.

Meanwhile, PE only stands for a company’s current share price in relation to its earnings per share (EPS). This ratio doesn’t take into account other important factors like future growth prospects, so it is only one piece of the puzzle when considering whether or not to buy a stock.

Price-to-book ratio (P/B ratio)

When it comes to stocks and investments, the term “PB” is used quite often. But what does it mean? PB stands for “price to book ratio.” The PB ratio is a measure of how much investors are willing to pay for each dollar of company assets. In other words, it’s a way to value a company by its book value.

The PB ratio is calculated by dividing the market value of a company’s shares by the company’s book value. For example, if a company has a market value of $100 million and a book value of $50 million, its PB ratio would be 2. This means that investors are willing to pay $2 for each dollar of the company’s assets.

The PB ratio can be a useful tool for investors. It can help them compare companies within the same industry and make informed investment decisions.

However, it’s important to keep in mind that the PB ratio is just one way to value a company. There are other factors that should be considered as well, such as earnings, revenue, and growth potential. For example, bank stocks have a very low PB ratio, but this doesn’t necessarily mean that they’re not a good investment.

Still, the PB ratio can be a helpful tool for those looking to invest in stocks. It’s a good way to get an idea of how much investors are willing to pay for each dollar of company assets.

Return on Equity (ROE)

ROE, or return on equity, is a financial ratio that measures the profitability of a company relative to the amount of capital invested by shareholders. It can be expressed as a percentage or per share.

The higher the ROE, the more profitable the company is considered to be. A company with a ROE of 15% or higher is generally considered to be very profitable.

ROE is often used to compare the profitability of different companies. It is also a good indicator of how efficiently a company is using its equity to generate profits.

You can choose stock according to ROE. For example, you can make a list of companies whose ROE is more than 15%, and then you can do other deep analyses.

Net Profit Margin

Net profit margin is a financial ratio that measures the profitability of a company. It is calculated by dividing net income by total revenue. Net income is the total amount of money a company earns after taxes and expenses have been deducted from revenue. 

Total revenue is the sum of all income generated by the company, including sales, interest, dividends, and other forms of income.

The net profit margin ratio is a useful tool for investors to assess the profitability of a company. A high ratio indicates that the company is profitable and efficient, while a low ratio indicates that the company is less profitable and less efficient. The ratio can also be used to compare the profitability of different companies.

Compare the Company Net Profit/Revenue/Operating Cash Flow with Other Companies with the Same Business

A good way to find out if a company is doing well is to compare its financial ratios with those of other companies in the same business. This will give you a good idea of how the company is performing relative to its peers. For example:

Compare Net Profit:Company A’s Net Profit/Revenue = 0.15, while Company B’s Net Profit/Revenue = 0.12. Although both companies are profitable, Company A is more profitable than Company B.

Compare Operating Cash Flow: Company A’s Operating Cash Flow/Revenue = 0.25, while Company B’s Operating Cash Flow/Revenue = 0.20. This means that Company A is generating more operating cash flow for each dollar of revenue than Company B, which indicates that it is a more efficient company.

These examples are just a generally explain of these ratios, you should always compare companies in the same business to get a more accurate picture, and to understand why and what makes such a difference. For example, is Company A’s products can sell at a higher price than Company B’s products?

4. Research the Company: Find Out What They Do and How They Make Money

Now that you’ve looked at a company’s financial ratios, it’s time to do some more in-depth research on the company itself. You should try to answer the following questions:

  • What does the company do?
  • How does the company make money?
  • Who are the company’s customers?
  • What are the company’s competitive advantages?
  • How does the company’s stock price react to news events?

Answering these questions will help you understand the company better, and will give you a good idea of whether or not it is a good investment.

5. Check the Company’s Debt Levels

Another thing to look at when researching a company is its debt levels. A company with a lot of debt may have trouble meeting its financial obligations in the future, which could lead to problems for investors.

Compare Debt Levels: Company A has $1 billion in debt and $2 billion in equity, while Company B has $500 million in debt and $1.5 billion in equity. This means that Company A is more leveraged than Company B, which means it is riskier if only looking at its debt. However, you cannot simply compare Company A to Company B in Debt Levels, you should compare their business model. Does A need more cash to general the same revenue as B?

Investors should always be aware of a company’s debt levels, as it can give them a good idea of the company’s financial health to some extent.

6. Dividend History

When you’re looking at a company, you should also check its dividend history. A company that has consistently paid dividends is usually a more stable investment than one that doesn’t.

We can understand that the company has real money instead of just net assets in the form of numbers on the balance sheet. The company is also likely to be a more mature business with a long track record.

A company’s dividend history can give you a good idea of its financial stability and its commitment to shareholders.

7. Revenue Growth and Net Profit Growth History

A company’s revenue growth and net profit growth play an important part in the long-term of a company’s stock price trend. If a company’s revenue and profit are both growing at a healthy rate, it is likely that the company’s stock price will continue to grow in the future.

In the process of analyzing the Revenue Growth and Net Profit Growth history, you’ll learn these two data are good in some years while bad in some other years. Try to find out the reasons behind and see if they are something you can live with it. After this process, you can understand the company and its business better.

8. Does the Company Runs the Same Business for Years or Engage in Other Business That is Not Related to Its Main Business

Different companies have different strategies. Some companies choose to focus on a single business and run it for many years, while others choose to engage in multiple businesses that may or may not be related to their main business.

There are pros and cons to both strategies. Companies that focus on a single business tend to be more efficient and have a better understanding of their customers and their needs. However, they may be more susceptible to economic downturns because they have a narrower range of products and services.

Companies that engage in multiple businesses may have a more diversified product line, which can help them weather economic downturns. However, they may not be as efficient as companies that focus on a single business, and they may have a harder time understanding their customers’ needs.

There is no right or wrong answer when it comes to this decision. It depends on the company’s goals and what strategy will help them best achieve those goals.

9. The CEO/Top Management of the Company

In addition to financial ratios, another important factor to consider when picking stocks is the management of the company. The CEO and other top executives play a crucial role in the success or failure of a company.

It is important to research the backgrounds/degree of the CEO and other top executives to see if they have a history of success. Meanwhile, it is recommended to check if the public speech of the management is reliable. You should also look at the compensation of the CEO and other executives to see if it is in line with the performance of the company.

10. The Industry in Which the Company Operates

The industry in which a company operates is also an important factor to consider when picking stocks. Some industries are more stable than others, and some Industries tend to grow at a faster rate than others.

It is important to research the industry in which a company operates to see if it is a good industry to invest in. You should also look at the competitive landscape of the industry to see if the company has a strong competitive position.

11. Choose Companies You Can Understand

You acquire a portion of ownership in a company when you purchase stock. You may not sleep well at night if you cannot understand what the company does, what its advantages, and whether the stock price is low, reasonable, or high. When you understand a company and its business, you have a better chance of making money from your investment.

12. Buy a Stock with a Margin of Safety

A Margin of Safety means if a company’s intrinsic value is 10 billion and you buy at 5 billion, you have a 50% Margin of Safety. 

This gives you a buffer in case the company’s intrinsic value is less than what you paid for it. The size of the Margin of Safety varies from investor to investor. Some investors may be comfortable with a smaller Margin of Safety, while others may require a larger Margin of Safety.

13. Diversify Your Portfolio

Investing in just one stock is a very risky proposition. If the stock price goes down, you could lose a significant amount of money although you insist that the company’s intrinsic value is much higher than your previous buying price. 

As you can imagine, seldom things can happen in investing market. For example, can you imagine the price of petroleum can be negative in April 2020? Thus, it is important to diversify your portfolio by investing in different types of stocks and asset classes. This will help to reduce the overall risk of your portfolio.

Diversification does not guarantee a profit or protect against loss in a declining market. It is a method used to help manage investment risk.

14. Decide How Much Money You’ll Invest in Stocks

It is recommended to invest money that you will not use in the next 5 years into stocks. This is because the stock market can be very volatile in the short term, and it may take a few years for the stock price to recover from a sharp decline.

If you need the money in the next few years, you should consider investing in other asset classes such as bonds or cash.

Final Thought

Picking stocks for beginners is not an easy task, but if you do your homework and understand the factors that affect a company’s stock price, you will be well on your way to picking successful investments.

When you are ready to start investing, there are a few things you should keep in mind. First, you should have a clear investment goal in mind. Second, you should diversify your portfolio by investing in a variety of companies and industries. Third, you should always remember that stock prices can go up and down, so you should never invest more money than you can afford to lose.

Hope you will be well on your way to picking stocks like a pro.

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