7 Things to Think About Before Buying a Stock
There’s lot of advice out there on how to invest, when to invest, what to invest in, and even why to invest. Enough books have been written on the stock market to fill libraries (or flash drives, these days), yet many investors struggle to keep up with today’s turbulent markets. One of the reasons for this is that it can difficult to judge exactly what steps to take when looking to invest in a given stock. Here’s a list of 7 of the most important things to keep in mind when thinking about the newest potential addition to your portfolio.
1. Know What the Company Does
You’d be surprised how many people are invested in companies while having no idea what the company actually does. It may seem like a trivial piece of advice, but it one that is often ignored. After all, how are you supposed to be able to know when to buy or sell a stock if you’re unsure of how the company makes money?
Keep in mind that this is often different from what the company is best known for. Consider that many automakers make substantial sums off of financing and loans rather than making a profit off of the vehicle itself. Also, remember that knowing what sector or area a company is in is not enough. There are thousands of stocks out there and, while few people know what all of them are about, knowing at least the basics about the ones that you are investing in is a good place to start.
2. Research the Company’s Fundamentals
Speaking of knowing the basics about a company, the next item on our list is to research a bit about the company’s fundamentals, including its balance sheet, government filings, investor reports, and the like. Publicly traded companies are required to file through the Securities and Exchange Commission, and the filings are compiled under the name Edgar at the SEC’s website. Picking out 10k and 10q forms for companies is a fine option, as they let you see a bit about the company’s financials.
If you don’t understand everything, that’s totally okay — it’s still not hard to realize that a company with high levels of debt may be a worse investment than one with lower debt levels. Earnings reports are also a good place to look, as they have information about a company’s performance as well as guidance for future quarters. Transcripts of conference calls are another resource to keep in mind as well.
3. Understand the Competitive Landscape
It’s business 101 that a monopoly can hold great value because it gets to charge optimal prices for the corporation. However, in today’s economic climate, few companies that aren’t under the protection of the government operate under monopolistic conditions. Knowing the competitive landscape that a company faces is key to understanding how it will perform in the future. If the company has assets that others cannot replicate, such as patents, copyrights, or trademarks, than those can act as sources of value in medium and long-term scenarios.
However, if a company has few such assets, then it is feasible that it will be run over by its competition. If you need more convincing, just think about how much better off Coke would be in a world without Pepsi!
4. Does the Stock Fit in My Portfolio?
An oft-overlooked aspect of picking up a stock is that it must not only be good in the abstract, but good in one’s portfolio. This has two components; one is the goal of the portfolio. For example, if you were interested in long-term investing, then you might want to pick slow-and-steady types of stocks. However, if you wanted some more speculative, then such stocks would not be the right choice for your strategy. The second component is balance. This means that a proper portfolio is usually diversified between companies and between sectors. You might have found the perfect hot pharmaceutical stock, but, if your profile is already heavy on the pharmaceutical sector, it might be wiser to either forego the opportunity or cut down on your positions in the other pharmaceutical companies to make room for the new entry in your portfolio.
5. Know How the Stock Responds to Economic News
Different stocks react in different ways to various economic conditions, which can include political changes, policy shifts, and international dealings. Understanding how a stock reacts to such trends is vital to grasping how it is likely to perform in the future. This is especially true with the continuation of quantitative easing. Some have argued that bad economic news, as it makes the policy more likely to continue, is met with better numbers on Wall Street.
While this is certainly not true for every stock, it is just one example of how counterintuitive the relationships between stock prices and economic changes can be. Additionally, be sure to account for economic trends in your diversification; you wouldn’t want your whole portfolio to tank on any single news story.
6. Have a Plan in Mind for the Future
Investing often requires not only a plan for what to buy and sell right now, but also a plan for when to buy and sell in the future. Having fixed price points at which you will trim from or add to a position is never a bad idea. Not only does this help you to avoid the trap of selling low and buying high, but it is also useful in taking emotions out of the picture. When the time comes, you may find it difficult to let go of a winner (or a loser), but remaining calculated as stock prices shift is of the utmost importance to wise decision making in the markets.
Keep in mind that it’s always okay to reevaluate if need be. Plans are not meant to be set in stone, but rather to give you a guideline to proper investing before you become involved in the ups and downs of a stock.
7. Be Aware of How Analysts View the Stock
It is also important to keep current on how those on Wall Street view a stock. With the internet so prevalent these days, it’s not even hard to do. This isn’t to say that you should exactly follow what analysts are doing. They are investing for a different audience and with different goals than you are, and it is clear that what is best for them is not necessarily what is best for you. However, this does not mean that you shouldn’t be aware of analyst opinions.
In the markets, a stock is worth whatever someone will pay for it, meaning that opinions can be powerful driver of share price. If a stock gets downgraded by multiple companies, its price may drop. That’s not to say that earnings and other fundamentals of the company don’t matter at the end of the day, but just being cognizant of how stocks are viewed by Wall Street will lend an additional degree of understanding to your comprehension of what makes stocks tick.
Here’s how the major U.S. equity indexes traded on Thursday:
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