6 Things To Consider When Choosing A Stock To Buy

March 15, 2019 · 10 minute read

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6 Things To Consider When Choosing A Stock To Buy

For many, the idea of beating the stock market and becoming a seasoned investing veteran holds an aura of allure and a way to prove big smarts.

However, before you go jumping into the market with both feet, you may want to slide in carefully, one foot at a time. Investing in stocks can be a great move for sure, but look before you leap and realize the factors to consider before investing.

First, you’ll need to get real. Ask yourself why you are investing. What’s your endgame? It could be retirement, a college fund, your family’s future, or just to grow your net worth. It could also just be to show off, but we’re going to concern ourselves with more meaningful outcomes for you.

Finding out which kind of stock investor you want to become and how the stock market works will can be a good way to serve your goals. There are two kinds:

Growth Investors

They’re often risk takers, more associated with the idea of big players, investing in high-priced stocks that you may not have ever heard of, with a lot of perceived potential.

Income Investors

They’re usually more conservative, favoring more sure, stable and well-established stocks, often called “blue chips.” Think of business icons like AT&T, IBM, Coca Cola and Boeing.

Only you can decide the type of investing that will best work for you. Often, younger investors give growth a try; older, more conservative investors stick with income. However, there is no law keeping you from deciding on one or the other; it’s completely up to you.

Considerations Before Investing

1. Buy What You Know — and Like

If you’re just getting started, you may want to stick with the companies you know, and the brands you use and trust. Trusting your gut and investing in something familiar goes a long way toward avoiding the hype that the stock market often thrives on.

Even if you hear great things about a company, not having a clear understanding of what they do or why they exist may mean that it’s not clearly defined as a business.

2. Learn the Company’s Present and Future Financial Health

If you like doing research and comparison shopping, you may like picking stocks. It all begins with reviewing the company’s financial reports. If a company is listed on a stock market, that means that it’s a “public” company, co-owned by stockholders (not privately owned).

By law, a public company has to offer quarterly and annual reports and file with the Securities and Exchange Commission (SEC). Be prepared to dig in your heels: looking over just one report is not going to cut it. You’re looking for consistency in the company’s past and present financial health, so that means going back a year or two, and with a fine-tooth comb.

What you’re looking for:

•  Earnings: This is the company’s after-tax income, also known as “the bottom line.” This is most often directly related to the company’s stock price and the most observed number by investors. Good earnings show that the company is profitable and successful. You can usually find them in quarterly and annual financial statements (be sure to check them both, going back a few years). Are these earnings consistent? Or do the earnings fluctuate from quarter to quarter and from year to year? Earnings tell a company’s story. Stocks rise and fall on this kind of information.

•  Operating margins: Also known as return on sales, this measures a company’s profitability. How much does the company make on a dollar’s worth of sales, after paying all the related costs (but before paying interest or tax)? Here’s the math: divide a company’s operating profit by its net sales. Another way to say that: divide the company’s operating income by its sales revenue. There are higher and lower operating margins (higher is usually better). A good number may mean that the company is well managed and its management has a clear vision. A lower number may mean that the company is a greater risk for investment.

•  Cash flow: this is a key indicator of whether your company is over- or undervalued. A high valuation but precious little cash flow usually doesn’t make for a healthy combination.

Know these and you will most likely know the current and future health of your company of interest.

3. Know the Company’s Long-Term Future with Asset Utilization

This number tells you how well your company is doing, and also how well it’s doing in comparison with its peers. The math works like this: if your company shows revenues of $100,000 and assets of $50,000, the asset utilization ratio is 2:1. Your company’s operations generate $2 in revenues for every $1 in assets. That’s not bad. How do similar companies compare to that?

4. Know How the Company Pays for its Business Operations

The term for this is “capital structure,” which is the amount of debt and/or equity a firm uses to fund its operations and finance its assets. The number to look for when researching this is its debt-to-equity ratio (sometimes called a debt-to-capital ratio).The company takes a periodic look at itself and decides if it needs more debt and/or equity to fund new or current projects.

The perfect mix is for the company to have both a nestegg of short-term liquidity to cover its operating costs, and enough left over for expansion and growth. What debt this figure doesn’t include: long-term debt.

5. Know the Company’s Earnings Patterns

The company’s ongoing earning power shows you where it’s been and where it is going. How is that earning momentum? Does it slow down or speed up during certain periods of the year? Given a certain time frame, you can recognize patterns in a company’s earnings momentum, which gives you a better understanding of it’s long-term growth potential.

The detective work includes looking at earnings reports over the last few quarters and any projections that are offered for the near future. If you see slow earnings growth, that could be a red flag, but it could be a result of other factors, like seasonal sales or changes in direction.

6. Know the Real Value (not the market value) of the Company

You may have heard the old stock-market adage “buy low and sell high.” That means to buy a “cheap” stock that will rise in value, then sell it at a higher price. This, of course, is easier said than done. If it were super easy, everyone would be a billionaire.

A stock’s value is measured by its price-to-earnings ratio (P/E for short). You get that number by dividing a company’s share price by it’s net income. Once you calculate that number, compare it to the P/E ration posted by other companies in the same industry. The lower the number, the “cheaper” the stock is. The higher the number, the more “expensive” the stock is, in comparison with the company competition.

Keep in mind that a cheap stock is not always a better buy, and that an expensive stock is not always something to steer clear. There are all kinds of reasons why stocks are valued the way they are, but you want a stock that you feel that will increase its value with time.

When using valuation models like this to determine a company’s worth, you’re looking at its intrinsic value. This gives you a clear understanding of a stock’s real value.

On the other hand, if you’re looking at how the stock is perceived by investors, that’s the market value. Market value has value too: a good perception by investors could raise the stock’s worth.

Other Considerations to Think About When Choosing A Stock

Buying just because you think the price is right. A stock suddenly plunging in price may be falling for a bad reason. Find out why the stock took a dip, and why it may come back and make you money.

Relying on just one guru. Listening to somebody with more experience explain stock recommendations — including when to buy and sell — could be both a positive and negative learning experience. You’ll learn quickly that even the most trusted experts don’t always get it right.

Letting a rollercoaster ride scare you. Unlike mutual funds, where you are investing in a diversified group of stocks, the value of individual stocks can fluctuate greatly.

Check the stock’s 52-week highs and lows to get a better understanding of how high and low the stock can go (remember that past performance is not an indicator of future performance, but the knowledge can give you a bit of perspective).

A Word (or Three) About Risk

You’re not in the game to lose, right? If you want to be more sure of not losing money, you can stash it in a simple savings account or bury it in the backyard. However, what’s safe isn’t always what’s best. Sometimes if you want what’s best, you have to take some risks.

If you’re hoping for a higher return, chances are you are going to have to get used to more volatility. If you drive a car, you’ll understand: every time you get into a car, you’re inviting risks, but if you keep your eyes ahead of you and stay aware and alert, you’ll get to where you want to go.

Youth is often the time for taking risks, because of the gift of time. Perhaps if you want to get more conservative and take fewer risks, the time to do that is as you sail closer to retirement age.

That is, of course, as long as you’ve successfully invested the amounts you need in order to retire happily. You can get a better of idea of where you stand by consulting SoFi’s retirement calculator.

Selling Stocks

All the tips in the world may not give you the perfect strategy for knowing the right time to sell a stock, but having a plan in place ahead of time may keep you from wringing your hands over the decision.

You may decide to sell when a price rises or falls to a certain point, if the stock is downgraded, or if the company suffers some kind of setback. Of course, this may take a little trial and error before you settle on a formula that works best for you.

Who Is Investing (Besides You)?

Jumping into the stock market may not be as crowded a pool as you may think. Only a little more than half of all Americans own stocks (54 percent), according to a 2017 Gallup report .

That includes individual stocks, 401(k) plans, mutual funds or IRA accounts. In addition, the Census Bureau reports that two-thirds of Americans do not participate in or have access to a 401(k) plan.

Turns out that the wealthiest Americans possess more than 80 percent of stocks, according to a New York University paper, “Household Wealth Trends in the United States.” The wealthiest 10 percent of households account for 81 percent of the total value of stocks.

Help from SoFi Invest®

Trying to wrap your head around the stock market and choosing stocks on your own can be a daunting task. It can frustrate even the most experienced experts, and not just once or twice. You may want to consider a trusted partner to help set you up, give you advice and help you with the long-term navigation.

SoFi financial advisors can work with you on a plan to achieve your goals. They’ll help you map out a strategy and then help you stick with it.

Remember, some investment risk can be reduced through diversification — investing in many types of assets. With an automated SoFi Invest account, we actively manage the assets for you and automatically rebalance them as needed.

Become a SoFi member and gain access to personalized advice based on your specific goals. Being a SoFi Member gets you access to over 200 SoFi events, as well as free professional career and salary guidance.

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The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. Advisory services offered through SoFi Wealth, LLC. An SEC registered Investment Advisor. SoFi Securities, LLC, member FINRA / SIPC .

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