How to Choose a Stock
There are thousands of stocks currently being traded on the market and contrary to popular belief, not all stocks are doing poorly. The proper research shows that certain stocks continue to grow in value and new, promising stocks are always going public. Finding the best stocks does not have to be a challenge. There are few simple guidelines that can be followed to help you choose a stock that is right for you and will make you a healthy profit.
1. Set Up Initial Screening Criteria
You need to have a set of criteria that quickly limits your options to a few choice stocks. The exact criteria may differ depending on your investment goals. Remember that all good stock research is based on quantifiable measurements. A few good criteria on which to base an initial screening are:
- Stability – are earnings and losses gradual and follow trends or are there surprises and flukes?
- Relative strength – is the company stable and does it have history?
- Industry – choose an industry in which you are interested and one that is relevant to society today. Gas lamps and pay phones are probably best avoided in this day and age.
- Earnings growth – over time, how has the stock done?
- Price/earnings ratio – are the earnings worth the price per share?
2. Analyze the Company’s Last Few Income Statements
Earnings growth should be in acceleration. Constant earnings are good, but you want a stock that tops itself every year. Revenue should also be growing. Profit margins should be stable or increasing. Falling margins means falling profits. Abnormal tax payments are also an indication that something is not quite right. If taxes are below 25% now they will drastically increase in the future.3. Check the Cash Flow
Cash flow should be positive and always increasing. The larger the numbers is usually better than a smaller cash flow.
4. Go Over the Balance Sheet
- Look for a low debt-to-equity ratio. Zero is perfect.
- Cash should be high. It gives companies some maneuverability should a tight situation arise.
- Inventory should rise at a proportionate level to sales. Growing inventory is a red flag.
- Accounts receivable rising without rising sales is also an indicator of future losses.
- Look for a high return on equity.
- The ratio of current assets to liabilities is shown in the current ratio. This should be high.
5. See what management is saying about their company.
The company should have a positive outlook with few potential threats and the future should be smooth sailing with no uncertainty. Check to see if the company is offering innovation by earnings on new products and services. In some industries, such as technology, research and development must be ongoing and new products offered every year. The long-term prospects of a company are extremely important for a favorable stock. Management should also be constantly looking for and hiring bright new talent.
6. Check dividends.
Dividends are more important if you are focusing on income and there is less of a wait compared to capital appreciation.
7. Who owns the stock?
You should be looking for a stock with plenty of insider ownership. If the CEO, other executives, and employees own most of the stock, then they have the most to lose should the company fail.
By following these guidelines, choosing stock becomes more of a science and you can always be assured that you made your choice based on data that shows promise instead of on a feeling with no one to blame but yourself.
