Why Stock Research Is Important
New investors often have the misconception that they must move quickly and make daily trades to keep up with the stock market. They’re probably envisioning a busy trading floor, brokers shouting, or think that it’s possible to get rich overnight.
But here’s the truth: With the exception of real-time fluctuations, stocks move rather slowly. An individual investor who is patient and thorough about their stock research is more likely to outperform day traders over the long haul.
Fortunately, you don’t have to be a finance professional or data scientist to excel in the stock market. To find the best stock investments, you just have to do some research and know what to look out for.
Why It Pays to Do Stock Market Research
Narrow Down Your Selection
You have limited funds and thousands of companies in which you can choose to invest. While you can invest in many companies at once through investment products like index funds or ETFs, buying individual stocks requires more discipline.
Keep a narrow focus on no more than 10 individual stocks to start with and build from there. Once you’ve done your research, you can identify the best companies in the overall market or in specific sectors that you’re targeting (e.g., technology, healthcare, or finance). Armed with that information, you’re less likely to be influenced by hype or speculation, and more likely to pick a long-term winner.
Discover Value Stocks
One way to build wealth through stock investments is to discover value stocks. The basic theory is that value stocks are priced lower than they should be due to an underestimation of a company’s long-term growth potential.
Identifying value stocks and investing in them early can potentially lead to low buy-ins and massive gains over time. This strategy was made famous by Warren Buffett, who at the time of writing had a net worth of $88 billion.
There’s a difference, however, between googling for value stocks and identifying them on your own. Conducting your own research can help you discover value stocks before others do, allowing you to make a really smart stock pick.
Avoid Bad Investments
Picking a stock can be confusing, even when you have a variety of data points at your disposal. However, stock research can help you identify red flags that may indicate a company is not worth investing in.
For example, suppose you identify a company that’s trading low at $25, and you like their product or identify with their values. Upon closer review, you discover that the company has been trending downward for the past several years, meaning that rock bottom has yet to come. You might also learn that the company’s primary product is becoming outdated. Or that there’s been a recent leadership change, and the company’s top talent is following the CEO to a new startup.
As you can see, the more data points you have at your disposal, the easier it is to make informed stock picks.
Next, let’s review some important measurements to consider as you perform your stock analysis.
How to Research Stocks
1. Conduct Quantitative Analysis
The current price of a stock does not necessarily represent the asset’s true value. The process of quantitative analysis takes into account hard metrics about a company in relation to the stock market as a whole, to help you determine if a stock or option is a good buy.
Here are some metrics to consider:
Price-to-Earnings Ratio (P/E Ratio)
The P/E ratio is one of the first things an investor looks at when evaluating a stock. It’s calculated by dividing a company’s share price by its annual per-share earnings.
A low P/E ratio could indicate a stock is undervalued, or that some stock analyst predicts low future growth. On the flip side, a high P/E ratio could indicate a stock is overpriced, or that analysts expect strong future growth for the company.
Price-to-Book Ratio (P/B Ratio)
The P/B ratio is a company’s stock price divided by its net assets. By analyzing the P/B ratio, you can determine how much investors are willing to pay for a company’s shares.
Price-to-Sales Ratio (P/S Ratio)
The P/S ratio is determined by dividing a company’s market capitalization by its annual revenue. A price-to-sales calculation lets you determine how a company is performing apart from its earnings reports.
Price-to-Earnings-Growth (PEG Ratio)
The PEG ratio is generated by dividing a stock by its expected annualized earnings growth rate over a period of time. This is another way of determining a stock’s value relative to its growth.
Debt-to-Equity Ratio (D/E Ratio)
Individual investors should be cautious about buying companies that carry too much debt, especially during downturns. Look at a company’s debt-to-equity ratio, which is calculated by dividing total liabilities by shareholder equity. It can tell you how reliant a company is on debt for funding.
Free Cash Flow
Take a look at a company’s free cash flow to determine how much money the company is producing. You can find this on the company’s financial statements (and more specifically on its cash flow statement). You can then use this cash flow analysis to understand why the company’s P/E ratio seems high or low.
A beta reading lets you know how reactive a stock is compared to the overall market. If a company has a beta of less than 1, the stock is less reactive to market fluctuations. A beta reading of 1 indicates that the company moves in a similar fashion to the S&P 500.
2. Conduct Qualitative Analysis
When researching stocks, you also need to go beyond quantitative reasoning and perform qualitative analysis. This is done by looking at a company’s soft metrics, which might include an organization’s business model, product set, leadership, governance, and related legislation.
You should also look at the company’s competitive advantage and if they are appropriately committing to research and development. This is crucial for a company in a saturated market with a lot of other players.
Qualitative analysis can help you get a sense of whether a company’s product is strong enough to remain in high demand. You can also learn how they’re planning for future growth and innovation.
Let’s say you’re considering purchasing the stock of a specific car manufacturer. You would be better off knowing, for example, if this car manufacturer is heavily investing in battery technology. Or are they behind the curve when it comes to green technology?
Alternatively, if the car manufacturer is facing regulatory or compliance issues (e.g., the Volkswagen EPA lawsuit) this might have a dramatic impact on its stock’s current and future price.
3. Gain Multiple Perspectives on the Best Stocks
You can be a lone wolf when investing and pick your own stocks based on your own research. But it’s still a good idea to gather perspective from expert investors and peers.
You can lean on a stock research tool for educational advice. Here are a few favorites.
Morningstar is an independent research firm that provides ratings and stock screeners to help investors make purchase decisions. One of Morningstar’s popular tools is Instant X-Ray, which can give you better visibility into your mutual fund holdings.
Check out Yahoo Finance for free stock quotes, portfolio management resources, global market data, and even mortgage rates.
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Frequently Asked Questions
What is Fundamental vs. Technical Analysis?
There are two different approaches you can take when analyzing stocks.
Fundamental analysis uses valuation metrics to show if a stock is trading at an appropriate price. Use fundamental analysis if you’re taking a long-term approach to investing.
Technical analysis looks at a variety of trading data like volume and price movement so you can make a trading decision based on patterns and trends. This method is primarily for short-term investing.
Most investors are encouraged to stick with fundamental analysis and think long-term. The strategy of investing in reputable companies with long-standing growth records wins more often than not.
Is now a good time to buy stocks?
In a nutshell, yes. The stock market is always going to have volatility. As an investor, you can’t control this. The only thing you can do is mitigate risk by spreading your investments around and diversifying your portfolio.
That said, new investors shouldn’t worry too much about market conditions when entering the market. Use the research methods mentioned above to identify opportunities and jump into the market when your situation and strategy calls for it.
Do you have to do investment research when buying stocks?
Investing without researching is not recommended. Of course, many investors do this without thinking twice, and some are better at guessing than others. However, it’s very easy to pick the wrong companies and wind up losing money when they underperform.
Inform yourself before you buy to maximize your chances of producing strong returns. The more prepared you are, the easier it becomes to recognize top-performing companies.
How can I tell if companies like Tesla are a buy?
It’s not always easy to tell if popular stocks like Tesla are a buy when there are so many conflicting research reports online.
The only way to tell if a company is a buy is to research the company and determine whether the data indicates that it’s a good time to make a purchase. Metrics like historical pricing, earnings per share, dividend yield, and market capitalization can usually give you a good idea of how a company is performing.
Just remember to think beyond the short term. If you believe in a company and like what it has to offer, consider buying it and holding it for many years.
What is a portfolio rebalance?
A portfolio rebalance is a strategy that investors use to adjust asset allocation. This is typically done to shift the weight of different assets and either increase or reduce risk to meet specific goals.
For example, early in your career, you may have an aggressive growth strategy that’s heavily built around equities. As you get older and approach retirement age, you will most likely want to rebalance your account and move away from equities.
Many brokerage accounts offer automated portfolio rebalancing, a feature most people are going to want to use.
Is the Wall Street Journal a good resource?
The Wall Street Journal remains one of the most widely-read financial publications for financial news and investment advice, with millions of readers across the globe.
While most of the information the WSJ offers can be obtained through other means, loyal readers swear by its advice and insights. Consider paying for the WSJ if you are looking for leading investing advice, along with daily updates from across the stock market.
The Bottom Line
The bottom line is that research is critical for success when investing in the stock market.
Think of it like this: Would you purchase real estate without doing a full inspection beforehand? Probably not. The same concept holds true with stock market investing.
Of course, doing your own stock research is not always easy, especially if you’re working full-time and have a family and other responsibilities. If this is the case, consider using some of the educational resources listed above to reduce the amount of legwork you have to do when hunting for information.
Be patient and make your best effort to learn as much as you can. And, once you formulate your strategy, write down a watchlist so you can closely monitor how your prospective targets are performing over time. If you follow this approach, you’re bound to make the right investment decisions.