How to Research Stocks – 5 Steps for Beginners
Individual investors can benefit from investing in stocks as it allows them to potentially grow their wealth over the long term and keep up with inflation. Stocks can provide both capital appreciation and dividend income. Additionally, having a mix of different stocks can help reduce risk and provide exposure to different parts of the economy.
However, selecting profitable stocks can be challenging for many investors owing to several factors. These include the overwhelming volume of information to analyze, the intricate nature of the stock market, and the unpredictability of stock prices.
Besides, a lack of expertise, emotional biases, and limited knowledge of financial analysis can further compound the difficulty in making informed investment decisions.
Investing in the stock market can be approached in different ways; some investors prefer to have their money managed by experts while others choose to take a more active role.
If you belong to the latter group and want to make informed stock investment decisions, there are steps you can follow to conduct thorough investment research and manage your investments like a pro. Let’s get started.
Step-by-Step Guide for Stock Research
1. Determine Your Budget and Risk Tolerance
Before researching stocks, it’s crucial to establish both your budget and risk tolerance. While there are different types of stocks, there is no limit to how much you can invest. To balance risk and returns, determine your comfort level for risk-taking and your return expectations.
Your budget plays a role in this decision, as smaller investments may require more significant risks to see desired returns. This is typical for those starting their careers, who have less to invest but more time to take risks. Knowing your position on this spectrum is crucial to developing an investment strategy.
2. Familiarize Yourself with Key Investment Metrics
To comprehend a company’s financial statements, it’s crucial for every investor to be well-versed in essential and straightforward investment metrics. These metrics include:
a. Earnings and earnings per share (EPS): Earnings per share is calculated by dividing a company’s earnings by the number of shares available for trading. This metric provides a per-share basis of a company’s profitability, making it easier to compare with other companies. While earnings per share is a useful metric, it has limitations and doesn’t provide information about how efficiently a company utilizes its capital.
b. Price-to-earnings (P/E) ratio: This ratio is a crucial valuation metric that compares a company’s stock price to its annual earnings per share (EPS). This metric is widely used in fundamental analysis and is especially useful for comparing companies in the same industry with similar growth prospects. However, it’s important to note that the P/E ratio is derived from the sometimes unreliable EPS calculation, and analyst estimates can be short-sighted.
c. Return on equity (ROE) and return on assets (ROA): These metrics show how efficiently a company generates profits. ROE calculates the percentage of profit earned per Rupee of shareholder investment, while ROA calculates the percentage of profit earned per Rupee of total assets. However, investors should be cautious as companies can manipulate these metrics by buying back shares or taking on more debt to boost their numbers.
3. Assess the Fundamental and Technical Analysis
Stock analysis can be broadly categorized into two approaches: fundamental analysis and technical analysis.
Fundamental analysis assesses a stock’s intrinsic value relative to its market price, identifying investment opportunities for value investors. By analyzing financial reports, investors can determine a company’s financial health and viability as an investment opportunity.
In contrast to fundamental analysis, technical analysis assumes that a stock’s current price reflects all available information and seeks to predict future price behavior through the analysis of price trends and patterns. Technical analysts scrutinize stock charts and look for patterns in the data to find trading opportunities, using various price and volume indicators to identify trends.
4. Keep a Tab on Market-Moving News
Staying informed of news that could affect the market can greatly impact an investor’s decision to buy or sell a stock. It’s crucial to have convenient access to news reports. With technology advancements, investors can now obtain news in numerous ways, including social media platforms which are now commonly utilized for real-time updates.
5. Practice and Learn
To reach your investing goals, you need to research stocks and understand your risk tolerance. However, applying this knowledge to actual investments is where the real challenge lies.
One way to improve your investment decision-making skills is to practice trading. Experience is an effective teacher, and simulated trading allows you to learn and refine your strategies before putting real money at risk.
The Bottom Line
Researching stocks involves collecting relevant information from trustworthy sources, examining critical data, asking pertinent questions, and comparing a company with its industry counterparts and past performance. These measures can help simplify the process of stock research and give you a better grasp of how to conduct it.