How To Research Stocks in 5 Easy Steps
If you want to invest in individual stocks, you’re going to need to do some homework. Researching the stocks you invest in will help you determine if your picks are performing well in their sector and industry, giving you a greater chance for success.
Here are five easy steps to research the stocks you’re thinking of buying.
1. Find a Research Tool
If you’re going to do your own research, there’s no sense in re-inventing the wheel. There are a number of good research tools you can use to give you great information on the stocks you’re considering. Many brokers have robust research platforms, including Fidelity, TD Ameritrade and E-Trade. You can also get comprehensive research from sites like Yahoo Finance.
Once you find a research tool you like, it’s best to stick with just one. The information that’s available on the platform is unlikely to change much from one tool to another — a stock’s price to earnings ratio is the same no matter where you find it – and getting familiar with a single tool will save you time.
2. Look at the Financial Statements
You can also find information on the company’s performance on their financial statements, which you can find on their website. Look for these forms:
- Balance sheet, which shows assets what the company owns, liabilities — what it owes — and shareholder’s equity — the difference, or what it’s worth.
- Income statement, which shows how much money the company earned over the past quarter and the past year. It shows how much money the company took in revenue, how much it spent — or its expenses and how much it earned or lost.
- Cash flow statement, which shows the cash coming in and going out. It shows how the amount of cash increased or decreased over the reporting period.
These statements will give you some idea of the health of a company, and provide the raw data for some of the calculations you may want to do.
3. Understand the Fundamentals
There are two kinds of stock analysis: fundamental and technical. Fundamental analysis seeks to understand the underlying metrics of the company to determine whether it is under- or over-priced by the market. Technical analysis uses charts to try to predict future market movement from past performance.
For most investors, fundamental analysis is easier to understand and more reliable than technical analysis. Here are five important fundamental indicators to know.
P/E ratio is the stock price divided by earnings per share. If a stock is trading at $50 per share, and had EPS in the last year of $2, its P/E ratio is 25. If another stock trading at $50 per share had EPS of $5, its P/E ratio is 10. A lower P/E ratio is better, since the company with a lower P/E is making more money relative to its share price.
Return on Equity Ratio
Return on equity ratio is the company’s annual net income divided by shareholder’s equity. It shows the amount the company makes for each dollar of shareholder’s equity. Shareholder’s equity is the total amount that all outstanding shares of the company are worth, often referred to as the “value” of the company. A company with a higher ROE than the industry average is generating good shareholder value, making its stock attractive to investors.
Price To Book Ratio
Price to book ratio is the company’s market capitalization, or the stock price times number of outstanding shares, divided by the most recent quarter’s book value. Book value is assets minus liabilities, much like net worth for individuals.
If a company has a book value of $20,000,000 and has a market capitalization of $100,000,000, it has a P/B ratio of $5. It’s important to understand what may be driving P/B ratios and to compare them across different companies in the same industry, as a high P/B ratio can mean positive investor sentiment, but a low P/B ratio can mean that the company has significant assets to back up the stock price.
Neither situation is necessarily better than the other, so look at P/B ratio in context.
Debt To Equity Ratio
Debt to equity ratio is a measure of leverage, or how much the company owes compared to its value to shareholders. When companies need money for operations, they can either borrow it–debt–or sell shares–equity. If a company has $50,000,000 in debt and $100,000,000 in shareholder’s equity, its debt-to-equity ratio is 0.5. This is a useful metric for comparing two companies in the same industry.
Profit margin is calculated by dividing net profit by revenue. This ratio how much net profit the company gets from a dollar of revenue. If a company’s net profit is $300,000 and its revenue is $1,000,000, its profit margin is 30%. Generally, the higher the profit margin, the better, but a ‘good’ profit margin varies by industry.
None of these metrics will give you much information on its own. The value comes when you use them to compare two or more stocks in the same industry that you’re considering.
4. Understand the Company
You can calculate these ratios for any company, and you can compare them with other companies in their industry. But if you don’t understand what the company you are researching does, you will be at a disadvantage when it comes to evaluating their stock.
“Buy what you know,” is a common investing adage, often attributed to Warren Buffett, arguably the greatest investor of all time. It’s good advice, and Buffett practices what he preaches.
For years, he avoided investing in technology companies because he felt he didn’t understand what they did. Apparently, it has since been explained to him, and his Berkshire Hathaway conglomerate now holds shares of Apple and other tech titans. But Buffett’s advice is still sound.
Why Is This Important?
Once you buy a stock, you need to decide whether to hold onto it or sell it. If you understand the company’s business and the environment in which it operates, you’re better able to determine whether the company is likely to continue to succeed. This will inform your decision whether to hold or sell.
Plus, when you buy stock, you’re buying a piece of the company. Would you want to buy something you don’t understand?
5. Consider the Company’s Values
The information discussed so far has focused on the company’s performance, which is critical to understand as an investor. But there are other considerations as well, such as the company’s values. These can include the way they treat employees, how they compete, their impact on the environment and even the political causes they support.
Reading the company’s annual report, available on their website and reviewing recent news articles will help you get an idea of what the company stands for. When you buy into a company, you want to be sure that its values are in line with your own.
Doing your own research on potential investments doesn’t guarantee that you’ll pick a winner every time, but it may give you a better chance at making money on your investments.
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- Fidelity. 2020. "How To Research Stocks."
- TD Ameritrade. "Independent Investment Research Tools."
- U.S. Securities and Exchange Commission. "Beginners' Guide To Financial Statement"
- Trading Strategy Guides. "Trading Strategy Guides Fundamental Analysis of Stocks."
- Corporate Finance Institute. "Return on Equity (ROE) - Formula, Examples and Guide to ROE."
- AP News. 2019. "The Latest: Warren Buffett Says Invest in What You Know."