Lesson 11: How to Pick a Stock
As you begin picking stocks and considering whether to invest or not, there are some obvious things to consider, and others not so obvious.
You’ll of course need to think about your goals, your needs, and your investment styles discussed in other lessons, but you’ll also benefit from a few additional concepts and terms.
As we discussed in previous lessons, there are a multitude of approaches to choose from, and this will guide you toward considering specific stocks.
For example, if you think you’d like to try a passive and low risk approach, you might consider a number of blue chip companies like Disney or IBM, as they are companies with decades of history, have an established business model, and are unlikely to change significantly.
Likewise, if you think you’d like to invest in large cap companies with growth potential, you could consider technology companies such as Salesforce, which is innovative and already quite large but is predicting continued rapid growth and development.
If there is a particular sector, such as automotive or cloud computing, that you think will grow in the coming years, because of articles you’ve read or expertise you have, then you can narrow your search into companies within that sector.
Yet the work doesn’t stop there. Your investment style, or philosophy, can guide you to a list of potential investments. There are still decisions to be made based on a few common measurements you can use to help guide you.
Common Statistics and Measurements
One of the first measurements you will find on investing platforms and finance websites is the P/E Ratio. The Price-to-Earnings Ratio is essentially a measure of how expensive a stock is. It tells you how much a share costs to purchase in comparison to how much profit a company earns per share. EPS or earnings per share, is simply total profit divided by total number of shares.
In other words, P/E ratio tells you how much you must pay for each dollar of profit a company generates. If a company has a P/E multiple of 10, this means investors are currently paying $10 for $1 of profit today. However, in reality they are paying for access to future earnings.
Yet P/E alone doesn’t necessarily tell you much by itself. It is much more useful in comparison to other companies in the same sector, which should have similar external factors affecting them. If a company you are considering has a higher P/E ratio than other companies, this may mean investors are expecting higher earnings growth for your potential company. On the other hand, if a company has a low P/E compared to the sector, it may mean investors expect less earnings growth or are less confident in the projected earnings growth. A relatively low P/E also may also mean it is undervalued. However, this means you are disagreeing with analyst expectations, and should have a number of reasons, from management strategy, product development, to possible M&A activity, for example, to support your position.
On a related note, revenue growth is an important statistic to consider. Wall Street generally expects companies to show growth along with the economy. Even though profit is ultimately more important to shareholder return, it is harder to assess on an ongoing basis as it can be affected by one time events, or potentially damaging moves such as cost cutting. Revenue is a more simplified measure of whether or not a company is successful.
Dividend Yield is an important measure for investors targeting stable dividend paying companies. It is simply a ratio of the annual dividend paid per share divided by the share price. In essence, it means how much of the share price you can expect to receive as a payment any given year. Many dividend paying companies pay around 2%, although some can pay 4% or more. By investing in these companies, you can have some expectation to receive at least this return, however companies usually pay dividends on a quarterly basis and can choose to stop doing so from one quarter to the next.
As we’ve mentioned, there are many influential analysts who dedicate themselves to parsing through the mountains of information available on individual stocks and make detailed projections for a company’s future performance.
From this analysis, they often produce what is called a price target. This is a projected price for a stock within a given period of time. Given that there are many different analysts working for a variety of firms and coming from different backgrounds, most investments will have a wide range of price targets. A share currently priced at $10 may have a 1 year price target of $15 set by one analyst, $25 by another, and $8 by another.
As an investor, you can take your time and read the analysis presented by each of these viewpoints, choosing to agree more with one or the other. You could also decide that maybe they all likely make some valid points and have their reasons for disagreeing. In this case, you could choose to consider an average price target, which balances these differences.
With these key statistics you should be able to move closer toward your first stock purchase, although it’s important to take a calm and measured approach as you begin.
Outside of these basic courses, there are more advanced resources both within ninety nine and on the internet. Our intention in creating these lessons is to give you the vocabulary and understanding of basic concepts necessary to learn more.
You may feel prepared to invest, and you certainly can begin with a conservative amount and a comfortable approach, but you should also view investing as a learning process, and not simply a skill you can acquire. We all begin at the same point, opening a brokerage account and buying stock, but the most successful investors are those who keep learning, trying to figure out what does and doesn’t work for them, what they are and aren’t capable of, and what they want to do next.
You may find that, after all, you just want someone else to do it for you. That’s okay, and many people chose to do so. What we hope though, in giving people access to the market, is for you to learn and decide for yourself.
Great, you've finished!
Other courses that you might like: