The Right Stocks To Buy: What To Consider

When it comes to managing your personal finances, playing in the stock market is a little like taking a fast, expensive car out on the freeway — it can be fun and rewarding, but you better know how to drive.

Trading in the stock market can be complex. That’s why most serious investors seek the professional help of a licensed broker, who spends their time analyzing the economy and the many industries and companies that are publicly financed by individual investors like you. When you’re committing a large part of your financial future to the stock market, a wise financial advisor can help you formulate a winning strategy.

But if you want to begin to build a portfolio without having to pay brokerage fees, picking the right stocks to buy is not so difficult if you start small and follow a few common sense rules.

Rule 1 is make sure you are only investing money you can afford to lose. This means you have plenty of cash to meet your monthly budget and have already set plenty aside for an emergency fund.

Rule 2 is prepare to stay invested for the long haul — the stock market is notoriously volatile in the short term. If you buy 100 shares of a blue chip stock, for example, and the price drops after 6 months, you might panic and try to cut your losses. But in most cases, the best thing to do is stay the course. In fact, over the long term the average return of the U.S. stock market is around 10% per year, adjusted for inflation, dating back to the late 1920s—a very solid return. That’s why a well-managed, diversified portfolio of stock investments is considered one of the best ways to grow your wealth in the modern economy.

While knowing which stocks to buy takes time and research on your part, you don’t need an MBA to invest successfully. There are no foolproof stocks, but there are safer investments than others. You just need to know the basics of investing to get started.

What Is A Stock?

Stocks, also sometimes called “equities,” are a type of security that gives stockholders a share of ownership in a company. As a stockholder, your share becomes worth more as the company grows in value. You can also earn money if the company pays out part of its profits in the form of dividends. Building a well-managed portfolio of shares in many companies trading in the stock market is one of the best ways to grow wealth, which is why stocks form the backbone of many retirement plans, pension funds and other long-term investment vehicles.

There are many types of stock in all sorts of companies, and they can cost anywhere from just a few dollars a share to several hundred. But in general stocks fall into the following broad categories:

• Blue chip stocks: As the name indicates, these are stocks in very large, well-known, established companies with a long history of success. Blue chip stocks almost always pay a dividend.
• Growth stocks: These are shares of companies that have very attractive possibilities for revenue growth. They can be expensive because of the high upside, but also riskier and more volatile.
• Income stocks: Stocks in very stable, predictable companies. Income stocks do not have the promise of high returns, but they consistently pay an adequate dividend.
• Value stocks: This term refers to shares in a company that is appealing to some investors, or viewed as a bargain, because it’s perceived as undervalued relative to what the company is worth. These are solid companies with good fundamentals (sales, dividends and earnings) and can be seen as a good bet for growth.

How To Find The Best Stocks To Buy As A Beginner Investor

If you’re just getting into investing and trying to decide on the best stocks to buy, prepare to do some homework. Here are the most essential first steps:

Decide How Much Risk Is OK

In building a portfolio of investments in stocks, one of your first decisions should be the level of risk you are comfortable with. Growth stocks offer a chance to make a larger score in a short period of time, but also have a greater risk of sharp declines. Meanwhile, income stocks offer small, consistent dividends, but they may take many years to begin to add up.

In general, financial advisors suggest a higher-risk, high-growth strategy for younger investors who have big goals and plenty of time to recover from any losses. For investors nearing retirement, the best strategy is much more risk-averse. If you’ve been saving and growing wealth for years, you’re better off maintaining the principal balance of your portfolio and taking smaller gains from low-risk stocks.

Read Reports From Reputable Stock Analysts

Stock analysts get paid to figure out which are the best stocks to invest in. If you’re getting into this game, one place to look would be to figure out what the pros are saying. They research companies and pore over publicly released investor information every day to make recommendations. Sometimes they work for large banks or mutual funds. Other times they might provide information to paying subscribers. All stock analysts have the goal of generating returns for the investors who use their information, proving the value of their service.

A lot of these stock market gurus publish information online. However, just because they spend their days analyzing stocks doesn’t mean they’re good at it. Any serious analyst will put their money where their mouth is and publish their record. Evaluate the returns and read the reviews of others before blindly trusting your investment strategy to any analyst. A good strategy would be to triangulate — find stocks that are consistently highly rated by several analysts.

Research Industries That Matter To You

Warren Buffett, co-founder of the investment firm Berkshire Hathaway and considered by many to be the most successful investor of the last 100 years, often preaches to “invest in industries that you’re passionate about.” If you’re reading about certain industries and watching what happens within them closely, this makes you more likely to be able to pinpoint good investments within that particular industry. You’ll know which companies are on the right track and you’ll also have a better understanding of the external forces that impact that industry as a whole.

In learning about one industry, you’ll likely begin to learn about other industries that are important to it and inter-related. This can help you embrace another foundational principal of investing — diversification. It’s good to have a lot of knowledge about energy, for example, but if your investments are too heavy in that industry you can take a big loss if there is a recession in the energy sector. But if you also have some money invested in blue chip stocks like Apple (tech), General Motors (automotive) and JPMorgan Chase (finance), your portfolio is protected, or “hedged,” against losses in the energy industry.

Check A Company’s Previous Stock Performance

Fortunately, tracing the performance history of a company’s stock is easily accessible from multiple sources online, such as Yahoo Finance, Nasdaq.com, Stock Rover and Morningstar, to name just a few. Stock analysts can dice up this data in many different ways, but a key indicator of performance is the stock’s price to earnings ratio. The “P/E” ratio gives a quick bang for the buck data point by dividing the company’s stock share price by its earnings per share.

Examine A Company’s Management

It’s important to be able to evaluate the management of a company as part of trying to determine its long-term prospects. For the more well-known companies, this kind of information can be gleaned not only from the company’s website and press releases, but also from any of dozens of top business publications who regularly report on them, such as Forbes, Bloomberg, Kiplinger and Investor’s Business Daily. While the press has biases of its own, their assessments of company leadership can be seen as more objective than a corporate press release.

Even smaller publicly traded companies are required to provide information to investors about company leaders and their vision for the business. While management stability in a successful company is always a good sign, sometimes a vibrant new leadership team can indicate growth for a company in a time of change.

4 Signs A Stock Is A Good Investment

In analyzing a company’s narrative and financial history, here are some of the key data points and characteristics that will indicate its stock will be a good investment.

1. It Pays A Dividend

Most people know that they can make money off a stock by selling it for more than what they paid for it. But it’s not the only way. You can also grow your account if the company pays a dividend.

A dividend is a payment made to shareholders of a company as a reward for investing. They are usually paid on a regular schedule from a company’s net profits on a per share basis. So the more stocks you own, the larger your dividend. So, not only does the dividend grow the value of your account, you don’t have to sell your shares to do it. Dividends are not available for every type of stock, however, so it is essential to do your research to confirm the type you are buying will receive dividends.

2. The Company Has A Good Track Record

As you do research on a company you’re considering investing in, look beyond the important financial indicators such as stock performance and price-to-earnings ratio. Look also at the company’s history, evolution and record of innovation. A company like Apple, for instance, has a lengthy record of innovating new products and upgrading existing ones. You can also look at a company’s investment in the future. Ford Motor Company, for example, has invested heavily in technology promoting autonomous vehicles, indicating its belief that the industry will move toward more self-driving cars in the future.

3. The Stock Has Performed Well Historically

It’s easy enough to do research on stocks that have performed at a consistently high level for a long time. These are not necessarily stocks that have risen significantly in share price—many grow the wealth of their investors by offering healthy dividends and sometimes buying back stock at a premium.

When you look at lists of today’s top stocks, you’ll notice that many are some of the world’s most recognizable technology companies, such as Microsoft, Amazon and Alphabet (Google).* These might be stocks to consider, but you should also diversity to other industries in the event of a slowdown in tech. Seek out companies in retail, electronics and health, as well as other industry sectors like automotive, energy and agriculture.

*Please note that this article does not endorse the purchase of any particular stock.

4. The Management Is Solid

In almost every case, a company’s performance—good or bad—is a direct reflection of its leadership. Look for company’s whose leaders exhibit a strong vision, receptiveness to change, the ability to manage often thousands of employees, adaptability to new and changing markets and, most importantly, responsibility to shareholders.

American business history is filled with stories of great turnaround CEOs who were able to engineer massive changes to benefit employees and shareholders, including Steve Jobs of Apple, Mary Barra of General Motors and Howard Schultz of Starbucks, who helped the coffee giant’s stock recover 143% in one year.

5. The Company Is In A Growing Industry

Your research should also seek out high-performing companies in industries that are still considered new or growing. If you could go back to 1986 and purchase stock in Microsoft for $21 a share, would you? Of course, not everyone has a crystal ball, but it’s safe to assume that leading companies in industries like biotechnology (Amgen), artificial intelligence (Nvidia) and autonomous vehicles (Tesla) could be a sound investment for some time to come.

4 Red Flags To Watch For When Picking Stocks

1. Penny Stocks

Penny stocks are those that trade at a very low price (about $5 or less), have very low market capitalization, are mostly illiquid, and are usually listed on a smaller exchange. These stocks are very speculative in nature and are considered highly risky because of lack of liquidity (meaning they do not have the cash reserves to cover setbacks), smaller number of shareholders, and a general lack of information about them. Penny stocks can often be sold to unsuspecting investors by shady brokers who convince them that the stock is the next big thing and will make them rich. The truth is many of the companies trading on the penny stock exchanges may go bankrupt in short order.

2. Delisting

A stock is "delisted" when it is removed from a major public stock exchange like the Nasdaq or New York Stock Exchange. The delisting may have been voluntary (perhaps the company chose to go private) or involuntary if the exchange decides to remove the stock from the exchange. When an exchange delists a stock, it’s typically because it no longer meets the minimum requirements for listing or it’s failed to meet some regulatory requirement. Often companies are delisted if their pre-tax earnings, market capitalization, or minimum share price fall below the thresholds required by the exchange. If this is the case, it’s a strong indication that the company is financially unstable and could pose a risk to investors. Do your research on any company that has been delisted before buying its stock.

3. Cyclical Stocks

Studies of U.S. economic history show that the overall economy goes through cycles that start low (often called a trough), rise through a period of growth that results in a peak, and then recedes again to a new trough — and on and on. Cyclical stocks are those that thrive when the economy is in a growth phase, and suffer during periods of contraction. While these stocks can produce excellent returns during a growth period, it’s very hard to know when that growth period is going to end. For this reason, cyclical stocks can be volatile.

Conversely, noncyclical stocks, also known as defensive stocks, are those that aren’t as dependent on the state of the economy – they sell goods that people tend to buy no matter how the economy performs, like food and health care. It may be a smart idea to have a balance of cyclical and noncyclical stocks in the event of an economic downturn or recession.

4. Shrinking Profit Margins And Dividends

Your pre-purchase research of a company should include a study of its management and stock market performance, but it should also take note of at least the last several years of profitability and dividend payments. If a company’s profits are on a downward trend this might indicate that it’s a risky investment. Likewise with dividends — shrinking payouts to investors over a number of years should have you thinking about moving on.

The Bottom Line: Let Research Guide Your Stock Investments

It’s been proven over time that one of the best ways to build your wealth through investment is by owning a balanced portfolio of stock in multiple outstanding companies. Picking which companies to invest in can be tricky. Purchasing a company’s stock should come only after you’ve done thorough research into its management, stock performance and dividend payout over time, and the overall health and prospects of its industry. We also always recommend working with a credible financial advisor before making any investment decisions.

If you’d like to grow your wealth in the stock market, start saving the funds you’ll need to invest with help from the Rocket Money℠ app.