You’re ready to start buying stocks. But as you look at all the stocks available, you may be wondering which ones to choose. What’s the best way to pick a stock? And how do you know which stocks might be right for your portfolio?
This guide will walk you through what you need to know about how to pick stocks.
Step 1: Define Your Investment Goals
Before you start exploring different stocks, think about what you’re investing for. Of course you’re investing to make money, but what do you want to accomplish overall? In other words, what are your investment goals? Figuring out your purpose can help you when you’re choosing investments and determining how to pick stocks.
Understanding Your Financial Objectives
What are you hoping to achieve with your investments? Think about this carefully. Is it retirement? Are you saving for a downpayment on a home or your child’s college education? Knowing your financial goals is very important to your investment strategy.
Also, consider your timeframe. Will you need access to the money in the next several years? If so, you may want to be more conservative with your investments. Or are you investing for the far-off future? In that case, you may be interested in stocks that have higher growth potential — with the understanding that higher-growth investments can also carry more risk.
Identifying Your Investor Profile
There are different types of investors. Pinpointing which type you are can help as you’re building your portfolio.
Investors who are looking for income (for instance, retirees who want to supplement their retirement funds) may want to buy stocks in companies that pay regular dividends. Investors who want to safeguard their money will likely want to look for stocks in companies that are stable. And investors who want to try to increase their earnings as much as possible might focus on buying higher-risk, higher-growth stocks.
💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.
Step 2: Learn the Art of Diversification
Diversifying your portfolio may help mitigate investment risk and may even improve investment performance, studies show. However, diversification is no guarantee and there is still risk when you invest.
The Role of Diversification in Risk Management
When you choose stocks, your inclination might be to stick to just a few companies you’ve researched and feel good about. This approach might seem like it could protect you from losses. But, in fact, limiting your portfolio could actually increase your chances of losing money.
Here’s why: Unsystematic risk is a risk that’s unique to a particular company or industry. So if you invest in the stocks of food manufacturers, for instance, and extreme weather damages some of the crops they use for their products, their stock prices could plummet, which could cause investment losses for you. But if your portfolio is diversified and holds a range of stocks from different sectors or industries, it helps mitigate risk. That’s because while one stock might drop, others could remain stable.
Techniques for Effective Portfolio Diversification
To build a diversified portfolio, there’s something known as the 60/40 rule that calls for investing 60% of your portfolio in equities like stocks, and 40% in fixed income vehicles like bonds and cash.
However, even if you’re building a strictly stock portfolio, you can still diversify it. Instead of owning shares in just one company, for example, you can buy shares in a number of different companies.
You can also choose stocks in different sectors, such as consumer goods, energy, and agriculture. And you can vary the types of stocks by buying stocks in a mix of small-, mid-, and large-cap companies.
If this sounds too complicated and involved, you might be interested in investing in mutual funds or exchange-traded funds (ETFs) that contain assets from many different companies. This is another way to diversify your portfolio.
Step 3: Research and Select Potential Stocks
Now you can start considering which stocks to buy. How to pick stocks? One strategy could be to go with a company for which you have an affinity or one that you’re quite familiar with. Think of the brands that are household names, for instance.
Once you have a few companies in mind, it’s time to find out more about them.
Conducting Company Research
When doing research on companies, these are some of the things you’ll want to look into: Are the companies profitable? How do they perform against others in their industry? Has there been bad news recently about them?
Here are some resources to discover more.
Company filings. The U.S. government requires most companies to file financial data on their performance and notable changes in the corporation. Look for the company’s quarterly and annual balance sheet, income statement, and the cash-flow statement. It’s also a good idea to look at each company’s retained-earnings statement and its shareholders’ equity.
You can find these on the company’s website under the Investor Relations section, or you can go to the Securities and Exchange Commission website to find any required filing. You’ll need to get acquainted with financial ratios. They will help you contrast and compare different companies so you can make a final decision. You’ll find them invaluable for selecting your first stock to buy.
Market news sites. Plenty of sites devote pages of content on what companies are doing, where sectors are heading, and how the market is reacting. Get in the habit of browsing a few every day. You can even set up alerts. That way, when you learn how to buy your first stock, you can keep up with all the news.
Deep analysis sites. Many companies offer stock-market research and make the task of evaluating stocks easier. Some offer information at no cost, others charge a subscription. Zacks Stock Screener and Stock Rover are examples of sites that do not charge. The sites that offer even deeper analysis, like Morningstar, may charge a fee. Many online brokerages also offer analysis content you can use.
Step 4: Analyze Stock Value and Performance
Next, you can look at the performance of the stock over time and its price to see if it represents a good value. Here’s how to do that.
Assessing Financial Health and Earnings
To evaluate a stock’s price, you can look at its price-to-earning ratio (you can generally find this information on the company’s website), which is a company’s share price divided by its earnings per share over the past year. If a stock’s PE is below its historic average, this typically indicates the stock is at a good price.
Another metric to check out is a stock’s dividend yield. If the dividend yield is above average, that could be an indication that the stock is at a good price.
These types of metrics can give you an idea of how profitable and efficient a company might be.
💡 Quick Tip: Distributing your money across a range of assets — also known as diversification — can be beneficial for long-term investors. When you put your eggs in many baskets, it may be beneficial if a single asset class goes down.
Step 5: Learn Risk Management in Stock Picking
A risk management strategy can help protect you from big losses. That involves never risking more money than you can afford to lose and knowing what your risk tolerance level is.
Balancing Risk and Potential Returns
How comfortable are you with risk? Are you the aggressive type who is willing to accept higher risk if it means you have the potential for higher returns? Or are you a conservative investor whose priority is to safeguard their money, so you are willing to accept lower returns for investments with lower risk?
In general, higher-growth stocks tend to be riskier, which aggressive investors may gravitate to. Stocks that are more stable and offer lower returns might appeal to a conservative investor.
Understanding how much risk you can tolerate, and balancing that risk with the potential rewards it might offer, is key to choosing which stocks to invest in.
Strategy for Long-Term vs Short-Term Investments
Investors who have a longer investment timeframe — for instance, those investing for retirement, which is 20 or more years away — may be willing to choose higher growth, higher risk stocks because they have time to try to recoup any losses they suffer.
Investors who are investing for the short-term — perhaps they want to buy a new house in two years, or their child will soon be heading off to college — may do best choosing a more conservative investment strategy to help maximize their savings and minimize their losses.
Step 6: Utilize Tools for Effective Stock Selection
There are tools that help you screen stocks. They’re available on many brokerage trading platforms, usually for free.
In addition, when selecting stocks, it can be a good idea to keep on top of news regarding the market in general as well as any specific sector or industry you might be interested in.
Navigating Stock Screeners and Tools
Stock screeners are tools that let you filter through many different stocks using criteria you choose based on your personal investment goals. You could screen by the industry or sector you’re considering, for instance, and by such data as on return on investment (ROI) or earnings per share (EPS). Look for these tools on brokerage trading platforms.
Keeping Up-to-Date with Market Trends
As discussed earlier, there are a number of market news sites you can follow to stay on top of the latest trends and happenings in the market. There are also financial podcasts you can listen to.
Step 7: Seek Answers to Your Stock-Picking Questions
Finally, before buying a stock, there are some key questions you should ask. These questions include:
• What does the company do?
• What is the company’s profit or revenue?
• What is the market for the company and who are the customers?
• What is the company’s price-to-earnings (PE) ratio?
• How does it differentiate itself from competitors?
• Why are you investing in this stock? What do you want it to do for your portfolio?
Once you research the answer to these questions, if the stock seems profitable and well-positioned for the future, you may want to consider it for your portfolio.
Picking stocks involves a number of steps, such as determining your investment goals, understanding your risk tolerance, and researching companies and stocks that are a good fit with your purpose for investing.
Consider carefully which stocks look strong and could help you meet your investment objectives. And remember to look for stocks that can help you diversify and balance your portfolio as you work to set yourself up for financial success.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
What is the best formula for picking stocks?
There is no one best formula for picking stocks. One strategy you can use involves several steps, such as: figuring out your investing goals, researching companies to make sure they are a good fit with your goals and that they’re profitable and have a good business plan in place for the future, and evaluating the stock’s price to make sure it’s a good value.
How does Warren Buffett pick a stock?
Warren Buffet’s strategy for picking a stock includes looking for stocks that are undervalued by the market in order to maximize returns. Buffet tends to buy stocks in businesses he understands and those that make sense to him. He also looks at a company’s management to see how it performs.
How do you know if a stock is good?
To help determine if a stock might be a good investment, get answers to questions about the way the company operates. For instance, how does it make money? How has it performed in the past? Are its products in demand? Is the company positioned for growth? Does it have a good management team in place?
Additionally, look at key metrics such as the price-to-earning (PE) ratio to help measure a stock’s value, and earnings per share (EPS) for an indication of its financial strength.
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