How to Research a Stock Before You Buy

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Investing, and doing so wisely, can seem like a fun and intimidating task at the same time. There are tons of investment options and you can spend a great deal of time trying to understand each investment stream or channel. The most popular asset people buy into, and often the first real attempt at investing, is to invest in the stock market. Essentially you’re purchasing a little slice of ownership of the company in which you bought stock in. If the company does well you’ll be able to sell at a higher price and enjoy the profits but there is also the chance that the stock will plummet leaving you with little to no return. It’s not just with stocks but in general the most difficult part to investing is the research that comes with it.

If you watch the news or read any finance focused literature you probably see tons of tons of discussions around investing, company performance and where people should be putting their money. The media today does a great job at putting certain brands and stocks in front of you with little reasoning to back up why you should consider them. When selecting a stock, there are several items you need to consider, and many others that you’ll probably want to.

Best Sectors to Invest In

First, you’ll need to identify the sector, or industry, you wish to invest in. It’s one thing to say you want Apple, Amazon, and Google, but without understanding that you need diversification you are setting yourself up for risk. By identifying the sector you wish to invest in, you can then begin researching sector risks.

Sector risks for example would be the job market shrinking, causing people to not purchase homes and negatively impacting the housing market. The sector risk in that situation is a shrinking job market. When you identify the sector risks, you’ll be more prepared to adjust your portfolio accordingly.

Stock Valuation

Next is to understand the valuation of each stock you are researching. When investing you’ll want to find undervalued companies because this will give you the best chance at making larger returns. To evaluate a stock, you should compare it against its peers within the same sector of the market.

For example, Apple and Microsoft can be compared together and a metric most commonly used is the Price to Earnings ratio, or P/E for short. While this data point alone is nearly meaningless, when used in a comparative manner can illuminate a stock that may be trading at a discount. If the tech sectors P/E is 10, and Apple is trading at a P/E of 8 and Microsoft is trading a multiple of 13, then Apple may be the company you research first.

Also, within the valuation you’ll want to understand the EBITDA (Earnings before interest, tax, depreciation, and amortization) growth, cash flows, and assets as these are some of the driving forces of a company’s performance. If you notice iPhone sales are down, investigate how that impacts both top line and bottom line numbers.

Shareholder Value

Finally, you’ll want to research how the company is returning value to their investors. Typically, in the stock market there are two methods you will see – stock buybacks and dividends to shareholders.

With a stock buyback the company is purchasing stock back, thus creating a smaller supply of shares, which in theory should be pushing the price up. This is simple supply and demand and if the company is doing well, should provide true.

On the other hand, there are dividends, which are paid to shareholders as described by the company. While a dividend is great, it can also be a sign that the company is doing well and utilizing excess cash in a manner that benefits shareholders.

These are three points to begin your research on any given equity.

  1. Stock Market Sector – Choose the industry you want to invest in.
  2. Stock valuation – Find undervalued stocks within your sector.
  3. Shareholder value – What’s in it for you?

It’s important to understand the company and understand the investment because you’ll want to monitor the results and how they progress. Stocks can provide higher returns but with increased risk. However, with the proper research and due diligence you’ll be able to fund value in the marketplace.