7 Factors to Consider Before Investing in a Company’s Stock
Do you want to invest in the stock market?
The fact is that a great many investors magnify their losses by trying to “beat the market”. For example, in 2018, the S&P 500 saw a decline of 4.38%, yet the average investor sustained a 9.42% loss. Trying to outsmart the markets in the short term typically leads to failure.
When investing in a company’s stock, it’s important to take the long view. However, when stock picking there are certain aspects you need to look at.
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Here are the main factors to take into account when building your investing portfolio.
- Gain Access to the Right Data
The first step is to know how to analyze different companies. The reason why the rich are getting richer is that they make extremely analytical decisions based on institutional level data. They’re not taking stock tips from Reddit.
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- Assess Stock Stability
The first step to investing in a stock is to assess the stability of the company. Every organization experiences down periods. Zoom out and look at the company’s history over the last five to ten years. Does their share price fluctuate heavily?
High levels of volatility is a red flag because it means the organization isn’t on a stable footing. It’s also wise to compare their levels of volatility with their competitors. Similar patterns could mean it’s the industry standard, and therefore large fluctuations aren’t a red flag. As much as possible, try to avoid fast growing stocks as they are typically high-risk.
- Check Earnings Growth
Another factor to consider is the company’s earnings growth. This can be checked by observing the company’s net gain over a specific period.
Are earnings increasing generally or do they experience dramatic spikes? Steady, consistent earnings are a positive sign that you could make a profit by investing your money in that company’s stock.
Consistent earnings prove that the company is well-managed and stable.
- Understand Debt-to-Equity Ratio
When looking at a company’s balance sheet, you’ll see that the majority of companies carry some form of debt. Debt isn’t always a red flag, as long as it’s sustainable. The number investors look at is the debt-to-equity ratio.
Companies with more assets than liabilities are running in the black and are unlikely to experience problems later. It could also indicate a potential higher return on investment because they may decide to expand their operations.
As a general rule of thumb, avoid companies with a debt-to-equity ratio of more than 0.30. Ratios above this are associated with higher risk.
- Do they Pay Dividends?
Stable companies tend to pay dividends to their shareholders. However, high dividends are not necessarily a good thing. Companies experiencing turbulent periods tend to increase their dividend payouts to discourage investors from selling.
A company paying high dividends likely isn’t reinvesting its profits in its operations or is desperately trying to retain market confidence.
To manage your finances with the least effort and risk, choose companies with modest, regular, and stable dividend payouts.
- What is the Price-to-Earnings Ratio?
Finally, pay special attention to a company’s price-to-earnings ratio. This number tracks the company’s stock price and compares it to its reported earnings.
Together with fundamental analysis, the price-to-earnings ratio can help you to uncover those undervalued and overvalued stocks.
To get this number, sometimes expressed as the P/E ratio, divide the share price by the earnings per share.
The higher the price-to-earnings ratio, the higher the company’s future returns are likely to be. Not all investors like to rely on this factor alone, but it can enable you to make an informed investing decision.
- The Role of Fundamental Analysis
Fundamental analysis involves being aware of the news headlines relating to the markets, specific industries, and companies themselves.
While it’s important to be aware of what’s going on in the world, fundamental analysis should never be relied on exclusively. Instead, it should be paired with an in-depth technical analysis of stocks. Ultimately, numbers are what tell the story, not journalists.
Any good investor is looking to invest and hold years into the future, so short term headlines play less of a role in their buying and selling decisions.
Avoid trying to “beat the market” because you’ll never do it. Instead, focus on consistent, regular gains over many years. The best money saving tips focus on being relatively conservative, rather than trying to nail huge profits.
Although huge spikes and taking advantage of market booms may be attractive, the market winners are those who conduct careful analysis and those who are in it for the long term.