How to Research Stocks
Back in the old days, if you wanted to research stocks, you needed a financial expert to help you. This was part of why investment tended to be the purview of those who had money to pursue it—namely, those who could afford the broker fees.
These days, the Internet changes the entire game of investing, and you don’t need to rely on an outside expert. You just need to know how to look beyond the technical specs and understand the details of a stock.
Here are some basic tips for any investor to get started researching stocks, from a total beginner to a seasoned investor.
Know Your Own Risk Tolerance
First and foremost, you need to know your own risk tolerance. In investing, risk tolerance is the amount of loss you’re willing to sustain when making an investment decision, and risk and reward are often two sides of the same coin. The more loss you’re willing to sustain, the more risk you’re willing to tolerate.
This is important to understand because you won’t make sound investment decisions if you choose investments that don’t match your risk tolerance. For example, if you choose investments that are riskier than you’re comfortable with, you’ll spend more time worrying about losses than capitalizing on potential gains.
Think of it on a spectrum. Conservative investors are more concerned with preserving initial capital than earning new gains, while aggressive investors are willing to take big risks for bigger payoffs. Most investors fall somewhere in the middle. Also, keep in mind that you become gradually more conservative as you get closer to the deadline for your investment goal so that you don’t lose everything.
Know Your Research Materials
Next, you should get familiar with your research materials. Think of this as your quantitative research stage, and it consists of pulling together key documents on the company whose stock you’re interested in.
The truth is, you could pull a whole library of documents. But if you’re just getting started, start with the Form 10-K and the Form 10-Q. Form 10-K is an annual report on a public company’s financial performance filed with the SEC, and it includes key information like the balance sheet and income management. Form 10-Q is the same basic premise, but on a quarterly basis, giving you a short-range snapshot of company performance.
These reports are fairly easy to find. If you have a brokerage firm, you can easily find those documents on the firm’s website, or you can find it on the websites of major financial news organizations.
Know the Types of Analysis
Once you have your materials, it’s time to analyze them. There are two basic analytic routes to get started in stocks:
- Fundamental analysis
- Technical analysis
Fundamental analysis focuses on assessing a stock’s intrinsic value, looking for stocks selling higher or lower than their intrinsic value. This is based on the assumption that the stock’s market price doesn’t accurately reflect the business’s underlying value.
Technical analysis takes a radically different approach. It assumes that the stock price reflects all available information and instead looks to identify patterns and trends in stock price movements in order to interpret the price action of the stock in question. The idea is that by analyzing a stock’s past performance, you can predict its future price behavior and whether it’s a good investment.
Know the Types of Metrics and How to Interpret Them
Regardless of the type of analysis you choose, you’re going to deal with some key metrics. You’ll see these crop up all the time in a company’s reports and analysis of the company’s performance.
For example, there’s the price-to-earnings ratio, which is a company’s share price divided by its annual per-share earnings. This tells you the relative value of the company’s shares and can also be used to compare current performance against past performance.
There’s also the price-to-earnings growth ratio, which is a stock’s price-to-earnings ratio divided by its earnings growth rate for a given time period. This helps you tweak the P/E ratio by accounting for the future earnings-per-share growth rate.
Of course, you’ll also encounter a lot of basic terms that are worth learning inside and out—like revenue (the value of all recognized sales in a period) or net income (the amount of accounting profit after paying all expenses). And before you dive into a single ratio, you should be familiar with earnings per share, a portion of company profit allocated to each outstanding stock (hint: it’s not just the sale value of the stock).
Know Your Qualitative Research Questions
Now that we’ve thrown a lot of numbers your way, take a breath and a step back from your calculator. Remember, stock values and usefulness as investment options aren’t determined solely by cold numbers. This is where qualitative research comes in—the collection of non-numeric data.
In the words of Warren Buffett, never invest in a business you don’t understand. So the most basic qualitative research question is simply, “What does the company do?” From there, you can build out to other questions, like how the company makes money (hint: it requires deeper digging than just stating they make X product).
When you’re looking at qualitative data, you’re looking at non-numeric factors that make a company a worthwhile investment, namely a durable competitive advantage and strong management practices. This requires more reading between the lines than your P/E ratio.
Know Your Context
This is also why it’s helpful to understand the context of the stock you’re interested in.
Rather than simply looking at the company right now, take a step back and look at its performance over time. Look at how it performed when the going got tough (and be prepared to read beyond company hype).
Basically, you want to create a complete narrative of the company over time. Once you do that, it’s easier to understand how its performance stacks up today.
Smart Investing Beyond Researching Stocks
Researching stocks is more than just a learning process. It’s a chance to make sure you have the right information to make a solid investment.
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