There is a lot to take into consideration when choosing stocks to buy, particularly if you are new to the world of investing.
There is some level of conventional wisdom among financial advisors that says that beginners should not establish their portfolios with individual stocks as opposed to low-cost mutual funds.
The reason for this is that there is significantly more risk involved in buying individual stocks and mutual funds track large bundles of stocks which just makes it easier for newbies to acclimate themselves to investing.
For investors who are a bit more seasoned and who have portfolios that are a bit more diverse, perhaps with some exchange-traded funds (ETFs) and the aforementioned mutual funds, individual stocks are a good choice just to further diversify and establish some balance.
One key thing to bear in mind when you purchase a stock is that you make yourself a shareholder in that company.
You are, in effect, a part owner of that company so the value of the stock and your potential return on the investment you’ve made are largely dependent upon how well that business performs.
But choosing a stock involves much more than just diversification. There are other things to implement into your repertoire when choosing a stock to invest in.
Valuation and Price
Experienced investors try to find cheap or undervalued stocks. If the price of a stock is low relative to each dollar that the company earns then that stock has a strong P/E or price-to-earnings ratio.
In the most general terms, if the P/E is under 15 then the stock is considered cheap. Stocks with P/Es over 20 are seen as expensive. It is best to do comparisons between the P/Es of different companies in the same industry to determine whether or not one is cheaper than those of its competitors.
Research the Company’s Financial Health
Before purchasing any stock, one of the smartest things any investor can do is to research that company’s financials. Every company that is publicly traded is required by the US Securities and Exchange Commission (SEC) to provide both quarterly and annual financial reports.
These reports can be found on the SEC’s website and more information about investor relations can be found on the company’s website.
The best stocks to buy are for companies that have a proven track record of consistent profitability rather than ones that show signs of sporadic financial health (a good quarter every few years).
Take Analyst Recommendations With a Grain of Salt
Most market analysts have earned their positions as such through years of experience in navigating the markets.
They can offer insight into the health and formidability of a particular company and the expected performance of its stock which can provide supplemental information when researching a company.
But many analysts have a tendency toward bias in favor of what are known as ‘buy’ ratings. Therefore, the sell ratings can be suspect, especially if it’s a new sell rating. Make sure that you are wary of this and only use analyst recommendations in conjunction with other research into a company when choosing your stocks.
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