How to pick a good stock | investoguideforteens

A SHORT GUIDE TO INVESTING

How to pick a good stock

Step 1: Decide what your investing goals are

People invest in stocks or other assets with different intentions. Some people want to invest in the long-term in order to save up money for the future, such as retirement or a child's college fund. This will ultimately change their investing strategies and types of stocks they invest in. They will focus on income stocks and other assets (like mutual funds or indexes) that will provide a good amount of money in the long-term and less risk. Though most of these people are adults, it's never a bad idea to have some money saved! Other people are seeking to earn money that they can spend on necessities and wants. Some want to speculate for a potential big gain (similar concept to winning the lottery), while others simply want to have more money in their wallet!

In your mind, picture an investing-style spectrum where one far end is growth and the opposite end represents income. It is likely that you incline more towards one side of this "spectrum". If you are more of a growth investor, you will focus on high-priced stocks that have strong growth rates and lots of potential due to their innovative products. However, several growth stocks come from newer, smaller, and less-stable companies that do not provide many dividends and may suffer from severe price declines. An example of a growth stock is Starbucks. On the other hand, income investors focus on slower-growing, stable companies that pay dividends. Income stocks are also known as blue chips.

Whatever your investing goal is, it will probably be influenced by your current life situation. If you're a teen or young adult seeking to save money for college, your first house, or even retirement, you are likely to pick a growth strategy. If you're retired or getting near to retirement, you will probably choose income stocks.

Step 2: Start with a company/industry that is familiar to you

Though this doesn't guarantee easy profit, starting with a company/industry that you already possess some knowledge about may help you understand their performance and why something might have occurred (e.g. increase or drop in stock price). As the American investor Peter Lynch once said, "Know what you own, and know why you own it." Also, don't get sucked in by the hype. I understand that when a stock is booming and receiving a lot of attention it's very irresistible to not buy it. However, it doesn't guarantee that this is the safest choice. Thus, unless you fully understand the company, don't always go for a stock just because it is being hyped.

The next few steps are more biased towards my personal strategy, which I made after doing research and practicing on stock market simulators. So again, you are not required to follow this as it depends on your goals, understanding, and investing strategy.

Step 3: Remember price and valuation

Many investors go for stocks that are "cheap" or "undervalued". Briefly, these investors are paying a relatively low price for each dollar the company earns. This might ring a call to you as this is the same concept of a P/E ratio. In general, a P/E below 15 is considered cheap, and P/E above 20 is considered expensive. However, like most things in the stock market, you must understand the reason behind the P/E ratio of a stock. For example, a company that's expected to grow rapidly will be more expensive than a bigger company that has slow growth. Thus, you must compare the P/E ratio to other companies in the same industry in order to see if it's cheaper or overpriced than other stocks. Moreover, a cheap stock doesn't always guarantee good profit and an expensive one isn't always bad. A stock might be cheap because its company is not growing as much or slowing down, which are not good signs! On the other hand, a stock might be expensive due to its highly expected growth in earnings over some time.

Focusing more on value, never overpay for a stock. You should try to calculate its lowest possible value and bid for that. Then you can sell it for a lot more when the stock price goes up and there you go: PROFIT! A good way to see this is by comparing average dividend yield by the current one. If the current one is more, this is a sign that it's undervalued. Furthermore, you can look at the price-to-book value, also known as the P/BV. Warren Buffett, one of the most successful investors of all time, uses this measure when determining the value of a stock. As a rule of thumb, the P/BV should be any value below 1.5. The lower the P/BV, the better as it indicates a safer stock. A below 1 ratio gives you instant profit. Warren Buffett then uses both the P/E and P/BV ratio to find if a stock is undervalued. Using his method, you would multiply both of these measures. Since the P/E ratio should be below 15 and the P/BV below 1.5, multiplying these two numbers equals 22.5. Therefore, according to Buffett, if the product is 22.5 or less, this is a strong indication that the company is worth looking at as the stock might be undervalued.

Step 4: Assess the financial health of the company

All public companies release a financial report every quarter and an annual report. You can find these online, but make sure that they are official reports! It is important to note that you shouldn't just focus on the most recent report. You should look at other quarters and years as you want to invest in a consistently safe company that is managed by vigilant leaders. Below are some brief ways to assess this:

See how much debt the company has. In general, a company with more debt is likely to have a riskier stock as more of the company's income has to go to debt payments. You should also compare the company's debt to other companies in the same industry in order to see if it's borrowing too much money in comparison to its industry and size.
Seek for revenue growth. In the long run, it is important that the company's revenue grows as this causes its stock price to increase as they are making more money. In addition, this increases the safety of the stock and ensures increasing earnings for YOU!
Consider profit margin. Subtracting the revenue by the company's expenses provides the profit margin. A company that's growing revenue and controlling costs at the same time will also have expanding margins. However, you don't want to invest in a company that has absurdly high expenses, as this increases the risk.
Consider dividends. Not only does a dividend provide more profit for investors, but it also indicates good financial health.
Look for a company with a high EPS. This shows that it is capable of generating a lot of dividend for us as investors (or it may reinvest the earnings back into the actual company and business to increase growth). However, it also depends on the market price of the stock: a very expensive stock would preferably have a high EPS, as this would generate more profit for us as investors. A low market price and high EPS might be good too. Going back to dividends, not only does it provide more income for investors, but it also indicates good financial health. Thus, make sure to look at he history of the dividend provide by the company (if it pays a dividend of course). Has the dividend increased or decreased?

Step 5: Come to a conclusion

Now that you know a basic step-to-step guide on how to pick a stock, it's time that you start completing each step. However, there are several other ways and strategies for picking a good stock. Therefore, don't stick to only this, it doesn't exactly ensure 100% safety and good profit. You can read several other strategies online and in books. Also, selling is just as important as buying a stock, so don't forget to sell! Here is a useful and reliable article that might help you with this: Wondering When To Sell A Stock? Use This 4-Minute Checklist.

Before you take off to do more research and hopefully buy your first few stocks soon, let's finish with my 10 Golden Rules.