Investing in individual stocks is risky, especially if you haven’t done it before. Many people are too scared to do it, so they stick to buying low-cost index funds instead.
However, don’t let them scare you. We think investing in individual stocks is a good idea and many experts agree with us. Aside from the fact that you’ll know what you’re investing in, mixing things up will also diversify your portfolio.
To do that, you need to perform smart research before investing.
Now, if you’re not comfortable doing that on your own, you can contact Triad securities. Their experience will help you maximize your investment without too much effort. But if you’re ready to fly solo, here are some tips on how to perform research.
1. Understand the Company’s Business
Before you start investing in individual stocks, you need to be familiar with the industry you’re planning on investing in. The American stock market can be divided into 11 sectors:
- Energy
- Materials
- Industrials
- Consumer discretionary
- Consumer staples
- Healthcare
- Financials
- Information technology
- Communication services
- Utilities
- Real Estate
Now, experts state that it’s best to include stock from all sectors in your portfolio. That’s easily done by investing in index funds because you’re not hand-picking a company. But things are different if you want to invest in an individual stock. You need to know what the market is like in the company’s industry if you want to invest smartly.
A company selling food won’t perform the same as a company selling cars, right?
2. Look at the Finances
The companies’ financial reports are probably the best source of information relevant for investing. Now, people get scared when they hear words like earnings per share, but don’t panic – you’ll master them in no time.
The two most important financial documents you should look for are Form 10-K and Form 10-Q.
Form 10-K is an annual report that includes audited financial statements – the company’s balance sheet, the sources of income, and how the company handles cash, revenues, and expenses. Form 10-Q, on the other hand, is a quarterly update that doesn’t include audited financial statements. While the latter may not be as reliable as the form 10-K, both are equally important and contain valuable information.
Since these reports have lots of numbers and words you may not be familiar with, here’s a little glossary:
Revenue
Revenue refers to the total amount of money a company has earned during the specified period. There are two types of revenue: the operating revenue and the nonoperating revenue.
The operating revenue is the amount of money that company has generated from its core business, while the nonoperating revenue typically comes from one-time business activities. Naturally, the first one is more important and reliable.
Net income
This is the amount of money a company has made once the operating expenses, taxes, and depreciation are subtracted from revenue.
Earnings per share (EPS)
Earnings per share show a company’s profitability on a per-share basis, which allows you to easily compare it with other companies. It’s calculated by dividing earnings by the number of shares available for trading.
Price-earnings ratio (P/E)
There are two types of P/E ratios you should be familiar with: a trailing P/E and a forward P/E.
A trailing P/E is calculated by dividing the current stock price by EPS, while a forward P/E is calculated by dividing the stock price by forecasted EPS in the next 12 months.
Keep in mind that since a forward P/E relies on potential EPS, it’s not as reliable as a trailing P/E.
3. Get Familiar with the History and Compare
Just because the company is doing well this year doesn’t mean it’s been doing that way in the past. For that reason, you should dig deeper and look beyond the newest financial statements.
We suggest that you use websites like Google Finance and Yahoo! Finance to perform research on historical data. Look into the financial statements from the previous years, as well as price charts and such.
This way, you’ll be able to tell you how resilient the company is, as well as how it reacts to market fluctuations and challenging situations.
4. Ask the Company’s Employees and Management
Most large public companies have investor relations departments that cooperate with potential investors by providing them with financial details, plans, and other potentially relevant data. They should be able to answer your questions about any press releases you might have come across, for instance.
So, don’t refrain from approaching them. Ask questions and pay attention to the information they give you. Are the company’s employees well-informed? Are they confident about things you’re talking about?
Also, pay attention to the management team and the company’s board of directors. If they’re all company insiders, they may not be able to objectively assess the management’s actions.
5. Never Stop Learning
It’s important to always be in the loop. Things can change in the blink of an eye and you need to be ready for that.
Blogs and email newsletters from reliable sources can help you do that. Books are also a valuable source of information, but so are magazines and online articles. Steer clear of forums, groups, and other sources with unverified advice. They might get it right from time to time, but you shouldn’t rely solely on those.
Conclusion
While index funds are a great way to start investing, individual stocks offer many advantages.
For instance, unlike with index funds, you only pay a fee when buying and selling stocks. There are no annual management fees. You also won’t struggle with managing your taxes because you’re the one deciding when you want to buy or sell the stocks.
So, investing in individual stocks is risky if you’re not prepared to do your research before the investment. But it definitely pays off.
