Thinking of investing in the stock market? The process may seem overwhelming. The options seem endless, and you may find yourself biting your nails, worried you might miss out on a sure thing.
There’s no crystal ball for determining market performance, but there are some basic methods you can use when it comes to researching stocks. In this post, we’ll show you how to do stock research. We’ll also give you some tips on how to research stocks for beginners.
How to Research Stocks for Beginners
When you first start researching stocks, you may find yourself learning a whole new language. And in a way, you are. So, let’s go over some of the basic financial vocabulary you’ll need to be familiar with when you’re researching stock performance.
Price-to-Book (P/B) Ratio
The price-to-book (P/B) ratio shows the value of a company if it were to be dismantled and sold today. Why is this important? Some companies aren’t exactly growing, but they can still carry considerable value based on assets such as property, bonds, and stock holdings.
Ideally, you want a low P/B ratio, which means that the available assets are higher than the price. This can actually protect you because these assets can ensure stability independent of market performance.
Price-to-Earnings (P/E) Ratio
The price-to-earnings (P/E) ratio is among the most important features to examine. A stock can rise in price, but without earnings to back it up, it can easily drop again. A company’s earnings are what keeps the price high.
For instance, if a stock is trading at $40 per share and has earnings of $5 per share, then it has a P/E ratio of 8. This means that it would take 8 years to make your money back if all factors remain the same.
Price-to-Earnings Growth (PEG) Ratio
The price-to-earnings growth (PEG) ratio is often used alongside the P/E ratio. The PEG ratio takes the company’s historic growth into consideration to determine the future of a given stock relative to other companies. This isn’t speculative; it’s mathematical.
For instance, you can calculate a PEG ratio by taking the P/E ratio of a company and dividing it by the year-over-year growth rate of its earnings. The lower the PEG ratio is, the greater the chances are of receiving a good deal based on the future estimated earnings.
Think of it this way: The P/E ratio gives you a snapshot of where the company has been. The PEG ratio shows you a graph of where the company has been. Armed with this information, you can make an informed decision about a company’s future.
A company’s dividend yield shows the payday that you’ll get for your money. Divide the stock’s annual dividend by the stock’s price, and that will give you a percentage. This percentage is essentially the amount of “interest” you accumulate on your investment, which can also grow as the stock matures.
Be aware, however, that dividends can vary by industry, and they can vary by year. Some stocks offer no dividends at all, which means you’ll rely exclusively on the performance of your base stock.
Research Stocks by Gathering Information
In order to research stocks, you’ll first have to pull your materials together. You’ll want to pay particular attention to two essential pieces of data:
Form 10-K is an annual report that shows the company’s financial performance. This includes the company’s balance sheet, sources of income, and revenue and expenses. The advantage of a 10-K form is that it’s been independently audited, which makes it more reliable.
While the 10-K form provides an annual report on a company’s financial performance, Form 10-Q provides a quarterly report on a company’s overall operation and financial performance.
These two forms will provide data that you can use to evaluate a company a bit more critically, a subject to which we’ll now turn.
How to Research Stocks by Evaluating Data
Now that you’ve armed yourself with the latest data, you can use this to scrutinize a company’s overall financial health. What factors should you evaluate when you research stocks?
Revenue refers to the amount of money a company earns during a specified period of time. Sometimes, you hear it referred to as the “top line” because it appears first on a company’s income statement. Think of revenue as the “gross salary” of a company.
If a company divides its revenue into “operating” and “non-operating” revenue, you’ll want to focus on operating revenue. Operating revenue refers to regular income, while non-operating income may reflect a one-time increase in assets from a sale, merger, etc.
You may already understand this “bottom line” figure, which represents the amount of money a company earns once you account for expenses like taxes, operating costs, and depreciation of physical assets.
Earnings & Earnings Per Share (EPS)
To calculate the earnings per share (EPS), simply divide the company’s earnings by the number of shares available to trade. This number will indicate a company’s potential profitability per share, which will help you compare companies prior to investing.
You may encounter the phrase “TTM,” which stands for “trailing twelve months,” giving you a time frame in which to better evaluate a company’s performance.
Return on Equity (ROE)
The return on equity (ROE) provides a percentage indicating the profit a company accrues with each dollar that shareholders have invested. This will tell you how efficiently the company uses its own financial assets.
Return on Assets (ROA)
The return on assets (ROA) is usually evaluated with the ROE. The ROA will provide a percentage that indicates the profits a company generates with each dollar of its assets. Again, this can be helpful in illustrating the efficiency with which a company uses its assets.
How to Do Stock Research by Asking the Right Questions
This information is critical, but so far you may simply have done little more than accumulate data. To make an informed decision before you’re willing to make an investment, you’ll have to assemble this data into a cohesive story.
To do this, you’ll need to consider several critical questions.
How Does the Company Generate a Profit?
This may sound obvious, but sometimes companies generate revenue in less-than-obvious ways.
Some businesses, for example, make more money from selling franchises than selling their core products. As a general rule, avoid companies whose business strategy you don’t fully understand, since this will make it more difficult to track your investment as the market ebbs and flows.
How Does the Company Intend to Compete?
Success naturally breeds competition. A company that sees early success may soon find themselves hemmed in as the market becomes saturated.
A television streaming service was once a novelty, but now that these services are ubiquitous, it’s hard to see how any one service can compete. Look for companies that innovate, always staying ahead of the competitors.
Can You Trust the Management Team?
The managers of larger companies often appear in interviews and speeches that can be accessed through a casual browser search. Smaller companies can be trickier to monitor, but the ascendancy of social media platforms has emphasized greater transparency among corporate leaders.
Don’t be afraid to track them down. Listen to what they’re saying. Some of this may be a gut-level decision based on their public personas—and that’s okay. What you’re really looking for is someone you believe you can trust, who can make wise decisions for the company you intend to invest in.
What Risks Are Involved?
Some stocks can plummet in the short term, but that’s nothing new. You want to manage long-term risks. What happens if the company takes a sudden, dramatic turn in their focus or their founder suddenly passes away? We’ve witnessed companies weathering these changes in the past, but you’ll want to consider every factor to determine your overall confidence in investing in a given company.
Are They Ethical?
You may also have moral or ethical questions about a company’s commitment to the environment or particular research and development practices. Ethical investing has become a lucrative business plan, but you may also want to use investigative websites to uncover any shady business practices that might give you pause. Don’t be afraid to put your money where your values are and invest in companies who share your vision.
Get Help When Comparing Stocks
The financial world is full of resources that are aimed at researching stock performance or helping you to compare and evaluate investment opportunities. At Gorilla Trades, our members have access to the leading research tools, as well as newsletters and updates to keep them informed about potential investments.
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