Investing in individual stocks can make your investing journey a lot more complicated.
That’s why personal finance experts recommend buying and holding low-cost index funds for the long term rather than trying to time the market with individual stocks. Index funds track the entire market (or sections of it) rather than individual companies, providing an easy way to diversify your portfolio and spread out risk.
For that reason, individual stocks should have a smaller allocation in your portfolio. “I personally recommend 80% of your portfolio in index funds and 20% in individual stocks as a starting point for your overall investments,” says Maggie Gomez, a Florida-based Certified Financial Planner and money coach.
Whenever you are ready to start adding individual stocks into your portfolio, here are five ways to research the best stocks, and expert tips to keep in mind while doing so.
Getting Started: The Different Kinds of Stocks
First, it’s important to know the different types of stocks. Typically, when people refer to stocks, they’re talking about blue chip stocks, which are those sold by large, reputable companies and generally considered household names. Examples of blue chip stocks include Google, Amazon, Starbucks, and Bank of America. But you don’t have to limit yourself to the big names only; stocks of smaller or newer companies can still be a good part of a balanced investment portfolio, provided you assess the risks carefully and do your research.
Investors can think of stocks as falling into one of four groups, explains Adam Lynch, senior quantitative analyst at Schwab Equity Holdings. There are large cap growth stocks, large cap value stocks, small cap growth stocks, and small cap value stocks. “Knowing these terms will help you know what’s going on,” Lynch says.
Each group poses differing levels of risk. Large cap stocks are typically associated with companies worth more than $10 billion. Small cap stocks are calculated as companies with about $300 million to $2 billion worth of shares in the market. Growth stocks are from companies that demonstrate above-average earnings and potential. Value stocks are those trading at a lower price than what they might be worth, signaling to value investors that they can get a good deal.
These categories are speculative based on market performance, among other factors like a company’s profits, the dividends it pays, and what’s going on in the industry or the economy. That’s why knowing your risk tolerance and choosing an investing strategy is equally as important as researching companies and stocks.
Other factors to consider when researching stocks include the industry a company is in, whether a stock pays dividends, and the total market value of a particular company’s shares (known as market capitalization, or market cap). Investors should aim for a diverse portfolio representing a range of industries (like energy, materials, banking, and consumer staples). Similarly, it’s best to include a percentage of stocks that pay dividends in your portfolio, along with a good mix of stocks that have large and small market capitalizations.
How to Evaluate Any Stock: 5 Ways to Get Started
The best stock to invest in is the one you understand. You’ll want to know how the business is trending, if the company is profitable, what its future goals are, and how aggressively it’s hoping to expand. All of these factors influence how fast your money might grow, should you choose to invest.
You may be looking to invest short-term with growth stocks, for instance, or snag a great deal on an undervalued company with value stocks. Once you have your financial aims in mind, you’re ready to research which companies match your risk tolerance, investing style, and timeline.
The most accessible place to begin researching stocks could be directly from your online broker. For example, Fidelity and TD Ameritrade both offer excellent, in-depth information about stocks for their customers. Check to see if your broker offers any research tools.
Another free source is Yahoo Finance, where you’ll find a variety of resources, including a stock screener with a variety of filters for easy searching. Gomez recommends TipRanks “because it compiles analysts and comes up with price targets. An ordinary person can review the analysis and see what lines up with what they want to see in their portfolio.”
There’s also Morningstar, which is considered a leader in stock research and analysis. The free option provides plenty of free insight, or you can register for the premium version if you want a deeper dive.
Compile research from several different sources when you’re evaluating which stocks to buy, including balance sheets and online sources. Also consider your personal experiences with the company, which is often the easiest place to start.
Whatever you land on, you’ll want to get a sense of a company’s track record, earnings rate, and what you can reasonably expect in the future based on market trends. Use filters to narrow down based on the industry you prefer, the growth level you’re looking for, and other factors. If you get lots of results, get more granular and keep filtering to shorten the list – then you’ll be ready for further analysis.
Let’s talk about some of the most effective methods.
1. Technical analysis
This is when you use all available information, including past performance and prices, to identify potential patterns and therefore, future price behavior. “Technical analysis assumes the price is real and reflects the value of the company,” Lynch adds.
Technical analysis is useful for short-term growth or price changes and focuses on potential gains as opposed to a long-term growth track.
2. Fundamental analysis
If you have an eye toward long-term growth with buy-and-hold stocks, you’ll likely want to use fundamental analysis. It’s when you use valuation and other past growth indicators to determine if a stock is attractively priced – and also assumes that a stock’s price doesn’t tell the full story about the company’s value. For example, if a startup is saving big cash reserves, its share prices may be low. But using fundamental analysis can indicate the company has big plans for the future.
3. Reach out to management
Many large public companies have investor relations departments that can provide financial details, future plans, and answer questions about any news or press releases you might’ve come across. This can give you a sense of the overall organization. Do the employees appear empowered and knowledgeable? Are they forthcoming with information? Was your call or email handled promptly?
As you interact, pay attention to the subtle cues that can give you a deeper understanding of the company culture. And if you’re inclined, ask which companies the management team is watching closely. This can give you ideas about where the company is heading — and which competitors are worth tracking.
4. Draw on your everyday experiences
Even if you use a stock screener like the one we mentioned above, you can use your own personal experience with a brand to guide your investment decisions. “People spend a lot of time searching when you can just look around your house,” explains Gomez. “What are you spending money on? Those are probably the companies that are good to invest in, especially just starting out.”
There are lots of companies that inspire fierce brand loyalty, like Costco, Target, and Southwest Airlines. If you have positive experiences with a company, that’s a reflection of all the efforts of management, marketing and customer relations to deliver a top-notch product.
Plus, what you personally understand and like is a good indicator of where you could potentially put your money for long-term growth.
5. Sign up for email newsletters
There are lots of newsletters that focus on stock picking. Choose sources with a history of returns for subscribers (this information should be on its website or in independent reviews). Newsletters could be a good way to get new options on your radar that you might not have otherwise known. Plus, subscribing to a new online resource could open you up to a community of like-minded people.
On the flip side, be wary of forums, groups, and sources with unverified and unaccredited advice. People love to speculate about the stock market, and while you may find some good tips buried here and there, be sure to do your own research before you invest money into a company you don’t know much about.
As you receive newsletters, pay attention to the recurring topics and names. Is there a company that always seems to be making news and posting profits? Read with an open, yet cautious, eye and see what appeals to you.
Key Terms to Know
Revenue is how much money a company made in a specific time period. It’s sometimes further divided into operating and non-operating revenue. If so, pay more attention to operating revenue, which is how much money the core business generated. Non-operating revenue is from one-time events, like selling assets internally. As you look at revenue, note the number over time. Is it going up, or at least steady? Was it able to weather volatile periods?
Net income is the bottom line – the total profit after all operating expenses, salaries, taxes, and depreciation are subtracted. This is what’s left at the end of the earnings period and gives you an idea of how profitable the company is over time.
Earnings per share (EPS) is a rough metric that shows how much each outstanding stock share earned during a set time period. It doesn’t give the entire financial picture because companies can reinvest the earnings in their business, or pay them out as dividends. But it can be helpful to compare businesses in a similar industry, or gauge whether the stock is focused on short-term or long-term growth.
Price-earnings ratio (P/E) shows a stock’s price compared with how much each share earned. For example, if a stock is $50 per share and earned $5 per share, the P/E ratio is 10. This is a common metric to use for companies in the same industry or sector.
Debt-to-equity (D/E) ratio compares a company’s outstanding debt to its overall shareholder equity. The idea here is if a company is holding a lot of debt, that it could be a higher-risk investment.