How To Choose Stocks: Things You Need To Consider When Picking Stock

How To Choose Stocks: Things You Need To Consider When Picking Stock

Stock investors usually have a hard time figuring out where to invest their money.

Reviewing massive amounts of public company data is very important for evaluating the quality of these said companies, and it’s often an arduous process.

How to choose stocks isn’t as easy as some experts make it out to be. However, if you know what to look for, it doesn’t have to be that hard either.

That said, there’s no such thing as a silver bullet when it comes to evaluating stocks. If you’re an individual investor, you’ll have to do your due diligence, and if you’ve got financial advisors, you’ll have to evaluate all their recommendations.

A few decades ago, it was tough for individual investors to get enough information on companies without being forced to purchase costly subscription services. Thanks to the rapid rise of the internet, stock investors can now access free, real-time company data with a push of a button.

The challenge nowadays lies in picking the right data for evaluating and assessing specific stock correctly. The internet has made how to choose stocks a tad bit easier than it used to be. Below are the factors you should consider before investing in stocks.

1. Price/Earnings Ratio

Price/Earnings Ratio

The P/E ratio is essential as far as the evaluation of stocks is concerned, and it has a pretty simple formula to boot: Price/share divide by Earnings/share. So if a stock is priced at $2 and its EPS at $1, the price/earnings ratio will be like 2.0x.

With that said, you don’t always have to have this formula in mind because it’s usually listed on the stock’s “quote page.” This formula is displayed to give investors an idea of whether the stock in question is either under or overvalued.

“Overvalued” is basically “overpriced” while “undervalued” is “underpriced.” If the stock has a very high PE, its price/share must be way more than its earnings/share. It means that the stock is overpriced or overvalued.

If it has a low PE, then the opposite is true. So, we’re saying here that you should be looking for companies with low PE ratios. The ones that range between 1.0x and 10.0x.

When the stock market is doing well, you can increase the range to about 10.0x and 20.0x. The PE won’t be listed if the company you’re looking at has a negative earnings/share.

2. Earnings Per Share (EPS)

Earnings Per Share

The formula that determines earnings per share is (net income minus dividends on chosen stock) divide by average outstanding shares. Earnings per share break down a company’s earnings or profit into individual shares.

As an investor, you should be looking for consecutive growth and positive earnings over each quarter. If a company doesn’t meet analysts’ earnings expectations, the stock price instantly decreases when the actual earnings announcement is made.

However, EPS has one huge flaw. A company’s accounting team can easily manipulate it. Nevertheless, it’s still something you should strongly consider before investing in a stock.

Another similar measure that’s become immensely popular is CPS or cash flow/share. Accountants may have the ability to make earnings look more favorable. However, cash can’t be manipulated.

Cash flow per share gives you a clear picture of how much money is flowing through the company and how much of it it’s got on hand. It can also tell you how effective the company’s operations are.

This piece of information will give you an idea of whether the company has enough cash on hand to settle its debts and take part in future business dealings that can help increase the stock price. You should be looking for companies that have both positive CPS as well as EPS.

3. Beta (Volatility)

Beta (Volatility)

Beta is what shows the stock’s volatility, or standard deviation. It’s kind of hard to calculate. However, many websites out there will provide you with it. Calculating beta is way more complicated than using it.

If the stock you’re considering has a beta measurement of 1.0, then it’s moving in congruence with the stock market. It means that the stock you’re considering should go up by 2% in a day if the S&P 500 went up by 2% on that same day.

If the market has a downturn, the opposite will happen.  If the beta measurement is 2.0, and there’s an increase in the market by 3%, then the stock should shoot up to 6%.

Sounds incredible until there’s a drop in the market of 3%, in turn, causing a 6% fall on the stock. A negative beta means the stock is moving opposite or inversely of the market. You won’t find many negative beta measurements out there.

Huge blue-chip companies are usually the ones with the lowest beta measurements. For instance, Microsoft’s beta hovers typically between 0.8 and 1.0 and moves with the market.

The behemoth pharmaceutical company Pfizer also hovers around 0.8, which means that if there’s a 1% increase in the market, its stock will only rise by 0.8%.

The highest betas are typically found with casinos. Theoretically, investors can make the most significant and quickest gains with stocks with high betas. However, they’re also at risk of losing quite a lot if the market underperforms.

4. Market Cap

Market Cap

The formula that determines the market cap is the number of outstanding shares multiplied by price/share. Keep in mind that when you own a stock, you own part of the company. If someone wanted to purchase the whole company, they’d have to acquire all of its stock.

Consider market cap as the overall price of the company, or how much the total cost would be to purchase the whole company. The market cap is what a lot of experts use to classify the company’s size.

The company’s size is then placed in the following categories; mega, large, mid, small, micro, and nano caps. The large and mega caps usually run in the billions of dollars. The small and micro caps, on the other hand, may only cost you a few million dollars or so.

What’s being said here is that the bigger the company, the more safe and stable it is. Though, just like with everything else in life, there are a few exceptions, like Enron and GM, of course. Think of the stability and sizes of stocks as trees.

Nano caps are small maple trees that can be violently blown around when a storm hits it (or, say, a market crash) and can also be easily uprooted (like bankruptcy).

Larger caps are similar to mighty oak trees that get very little damage when violent storms hit them. But, tiny maple trees can grow tremendously over a couple of years, while the enormous oaks have already matured and don’t provide much room for extreme growth.

Bottom line, when investing, ensure you take a closer look at the size classification or market cap to get a stock that matches the risk you’re willing to tolerate. Small companies have the potential for extreme growth, but with a lot more risk involved. With large companies, it’s vice versa.

5. Dividends

Dividends

If you can’t keep an eye on the market daily, and you want to make money without putting in that kind of attention, then look for dividends. Dividends are similar to savings account interest. You get your money regardless of what the stock price looks like.

Dividends are the distributions a company gives its shareholders from its profits. The board of directors is the one that usually decides how much dividend will be paid out to the shareholders, which are often handed out in cash. Though some companies can award you with stock shares as dividends.

Many investors typically hold dividends in high regard because they’re a source of steady income. Many companies pay them out at regular intervals, usually quarterly. Investing in companies that pay out dividends is a prevalent strategy among traditional investors.

They give investors that feeling of security when they’re going through periods of economic uncertainty. Huge companies that have got predictable profits are often the ones that issue out the best dividends.

Arguably the most well-recognized sectors with dividend-paying corporations include pharmaceuticals, banks, financials, oil and gas, necessary materials, and healthcare.

6% dividend payouts, or more, isn’t uncommon with high-quality stocks. Companies in their early stages, like start-ups, may not be profitable enough to issue out dividends.

6. The Chart

The Chart

There are so many different kinds of stock charts out there. They include candlestick charts, bar charts, line charts, so on and so forth. However, reading these said charts is nowhere near as easy as most people think. In fact, it can prove incredibly difficult sometimes.

Learning how to read these charts effectively is a skill that’ll take you quite some time to master. So as a retail or individual investor, what does this mean, right? It isn’t a step you need to overlook. Why?

Because essential chart reading really doesn’t require you to have a lot of skill. If a chart begins from the lower left side and travels all the way up to the upper right side, then that is a good thing. If it’s going in a downward direction, keep off and don’t bother yourself trying to figure out why.

There are so many stocks you can pick from without choosing the one that doesn’t make money. If you have faith in a particular stock, place it on a watch list and monitor it from time to time.

There are quite a number of folks out there who aren’t disheartened by scary-looking stock charts. However, most of them have the resources and research time you probably do not have.

7. Volume

Volume

Volume is the amount of the stock sold and bought in one day of trading. Ensure the average volume is over 50,000. If you find a low volume measurement, then this means that liquidity is low as well.

It again means that it’s difficult to sell and buy because there are not many sellers and buyers, and the stock moves around weirdly or in a choppy fashion.

It helps create unnecessary volatility, which a lot of investors generally avoid. That is why trading penny stocks can end up leading you into miserable scenarios.

8. Popularity/News

Popularity/News

News affects both the decisions and expectations of investors. Expectations, on the other hand, determine stock price.

Popular and famous glamour stocks like Apple, Facebook, or Yahoo are frequently in the news, and sometimes the hype brought about by the press can inflate their prices.

Try going for stocks that aren’t victims of television headlines and newspaper publicity. If you do it, you’ll have much smoother sailing in your stock investing.

9. Insider Activity

Insider Activity

Evaluate what’s going on within the company itself. If you found that its CEO or COO just did away with 60,000 shares, then it might be a good time to dump yours as well and get out.

People that work within the company know it better than anyone else. If the individuals in the company have been increasing the shares they’ve bought, it means there might be something good for you if you buy in as well.

Looking at what the people inside are doing is an excellent way to tell whether the stock is worth it or not.

Final Thoughts

How to choose stocks isn’t all about taking your money and putting it inside different investment vehicles. There’s a lot more to it than that. You really can’t hope to succeed with your stock investing without extensive and exhaustive research.

However, you can protect your assets by going for stocks with proven success records and investing in companies that pay out dividends. Hopefully, now you have a good idea of how to go about your stock investing.

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