Investing in stock is a really big deal. You’re not just putting money in a security and calling it a day. You’re becoming a shareholder in a company. It’s your duty to make sure:
- The company is one you believe in and can stand behind, and
- You’re actually choosing a good investment that won’t send all your money swirling down the drain when it goes bankrupt.
We created this step-by-step guide to walk you through how to research stock and choose the right investments for you (so you avoid scams, minimize risk, and end up with a portfolio you can be proud of).
1. Define Your Investing Goals
The first thing you need to do is define your reason for investing. Is it to generate supplemental income in retirement? Preserve your wealth? Grow your assets? Your goals will dictate your strategy, so take time to define those first.
- If your goal is to generate supplemental income, you may look for stocks with good dividends.
- If your goal is to preserve your wealth, you may create a moderate portfolio made up of stable blue-chip stocks and maybe even a few bonds.
- If you’re looking to aggressively grow your assets, you may look for younger companies that are poised for significant growth over the coming decades, knowing it may come with more risk.
2. Make a List of Companies You Want to Invest In
Investors like Warren Buffet and Peter Lynch swear by the philosophy of “investing in what you know.” There’s actually some truth to this. If you don’t understand how a company makes money, it doesn’t matter what their financial statements say. You won’t be able to understand their products, pinpoint their competitive advantage, or project their future earnings.
When making a list of companies you want to invest in, think about the brands you already use and swear by.
For example, if you use Gain laundry detergent, Charmin toilet paper, Puffs tissues, Dawn dish soap, Crest toothpaste, and Gillette shaving gel, then guess what? You use a lot of products made by Procter and Gamble. If you work in the tech industry, you may keep up with every press release from Tesla, Google, and Apple.
Look at the brands you interact with most and start there. Your basic understanding of how these companies work will help a lot when you move onto step #3.
3. Review Those Companies’ Financial Statements
All publicly traded companies must file Form 10-K and Form 10-Q with the U.S. Securities and Exchange Commission (SEC). These two forms are GOLD for checking a company’s financials to see how viable it is.
Don’t get caught up in the form names or bogged down in all the numbers you see on those sheets of paper. There are just a few key sections you need to pay attention to:
- Revenue. The amount of money coming into the company
- Net income. The amount left over after expenses and taxes
- Earnings and earnings per share (EPS). How profitable a company is a per-share basis
- Price-per-earnings ratio (P/E). How much someone is willing to pay to get $1 in the company’s earning
- Return on equity (ROE). How much profit the company has generated for every $1 invested by a shareholder
- Return on assets (ROA). How much profit the company has generated from its own money
These ratios can be found on almost every brokerage firm’s website, so you may be able to skip over hunting down Forms 10-K and Form 10-Q if you already have an account. Simply search for the ticker symbol on your trading platform instead.
4. Then, Look Beyond the Financials
Researching stock is both quantitative and qualitative. You’ll look at some numbers, yes, but you’ll also look at the company’s leadership, mission, values, and best practices to make sure it actually deserves your money.
This type of investing is called value investing, and it was started by Benjamin Graham. The likes of Warren Buffet, Peter Lynch, John Templeton, and others have used his methods to amass millions and billions in wealth.
5. Build Your Portfolio
After you’ve done your research (both quantitative and qualitative), it’s time to start building your portfolio. There are dozens of brokerage firms in the US, the biggest of which are Charles Schwab, Fidelity Investments, E*TRADE, and TD Ameritrade. Some charge trading fees and others don’t so look into fee structures before you open an account.
6. Stay Vigilant Against Scams
Throughout history, there’s been no shortage of innocent investors who were blindsided and swindled out of their life earnings because they didn’t stay vigilant against scams. (Just check out Investopedia’s round-up of the biggest stock scams of recent times to see what I mean.)
Beware headlines and financial gurus promising to make you more money than you ever thought possible. And as the SEC recommends, always do your research, ask questions, and check answers before you invest in stocks or trust a person trying to sell you something.
What’s your process for researching stock and choosing a good investment? Share your tips with us on Twitter.