Choose Stocks

So you've decided you want to invest in stocks. Where do you begin? More importantly, how do you choose the stocks to invest in? Choosing stocks can be frightening but as long as you have information and tools, you can confidently pick stocks. Get information from the companies themselves, the SEC or the Bureau of Labor Statistics. Or get information and tools from your stockbroker. Either way, you have several options for choosing stocks.

Steps

Using Macro Analysis

  1. Understand how macro analysis works. Macro analysis has its basis in the large (Macro) tendencies observed in the economy. Your goal is to understand how major forces are affecting the performance of the economy. Then, base your investment decisions on your findings.
    • For example, if the economy is performing poorly (inflation and unemployment are high while national output is low), avoid overpaying for stocks and be sure to diversify your stocks.[1]
  2. Gather data or access a graph. The most important macro indicators include: GDP (gross domestic product), CPI (consumer price indices), PPI (producer price indices), unemployment rate, interest rates (Fed Funds, prime rate, etc), inflation rate, and balance of trade. You can either download the historical data to Excel or access an interactive graph using online tools.[2]
  3. Observe and interpret the data. Look for the general direction that the numbers are moving in and any patterns that may emerge. Take into account: the historical data you found, current data, and news. The website will have a separate series of data already converted to percent for either Year over Year or Quarter over Quarter.
    • If not, you can determine the percentage of change for an indicator. For example, divide the nominal GDP (in numbers) of one year by the value from the previous year. This gives you the GDP growth percentage for Year over Year.
  4. Pick your stocks. Investing in a broad based stock or stock alternative might be the most convenient with this method of analysis. Select a group of stocks that reflect the movement of the broader economy and track an index like the Dow Jones Industrial average or S&P 500.[5] This approach allows you to enjoy the growth of stocks in the US in general without risking all your money on one or just a few stocks.
    • Understand that macro analysis doesn't specifically help you decide which individual stocks to buy. Instead, it simply lets you understand the performance of the economy. For example, you may want to buy stocks when you think the economy will improve and sell when you think it will deteriorate.

Using Fundamental Analysis

  1. Decide if Fundamental Analysis is best for you. To use fundamental analysis, you need to determine what you think the stock is really worth, or its estimated value. This won't necessarily be what the stock is currently being traded at. If you decide the value is higher than the current stock price, buy. If you think the value is less than the stock price, sell.[6]
    • Don't expect clear results. The value is subjective and other investors often come to different conclusions.
  2. Look at the variables. To determine the current and future value of a company, here are a few variables to look into:[7]
    • P/E (price to earnings ratio) - a negative ratio may suggest that the company isn't profitable
    • EBIDTA (Earnings before interest depreciation, tax and amortization) - this is a form of net income with much of the accounting already taken into consideration
    • free cash flow - this represents money that the company has to pursue opportunities that may increase their stock's value
    • debt ratio - this is a percentage of the company's total debts to assets
  3. Gather the data from the Securities and Exchange Commission (SEC). You can find the information in the company's SEC filings or earnings reports. Order a company report by contacting the Investor Relations area of the company. Their contact information will be available on their website, which may even offer a link to download the reports.
    • You can also use the EDGAR (Electronic Data Gathering Analysis and Retrieving) system of the SEC to view or download this information.
  4. Search for information. Full-service brokers, research firms, and the internet are full of free and for-purchase reports.
    • Note that many online brokers limit public information available.
  5. Pick your stocks. Once you have all the information you need, make a decision about the value of the company you're considering. Use the data to determine the value of the company. Then, buy stocks based on future projections of earnings or good news about the company.
    • You can try using relative value to compare similar assets of different companies. When doing so, try to stay within the same sector when choosing companies to compare. For example, you may want to compare Apple, IBM, Lenovo and Hewlett Packard - Compaq.

Considering Technical Analysis

  1. Decide if Technical Analysis works for you. Unlike fundamental analysis, technical analysis, or charting, doesn't focus on estimated value. Instead, it charts the price movements in the stock market. This way, short-term trends emerge and you can use them to make subjective decisions about the future value of a stock.[8]
    • Most technicians are traders, not investors, so long term trends are not useful for their investing decisions. Price movements are used to determine short-term investor psychology since prices move on rumors, misinformation, and unexpected news.
  2. Check out online tools and charts. One place where you can educate yourself is at Stockcharts.com.[9] They have simple, free, comprehensive and in-depth materials available online to understand Technical Analysis.
    • Investopedia has an interesting article which can help you to investigate what software packages are available and what best suits your needs.[10]
  3. Use a stockbroker. Many brokers offer some guidance and tools on their sites. If you are interested in technical analysis you will want to investigate what each broker offers. Visit their websites and talk to them to find out what tools they offer.
    • Full-service brokers offers a variety of advice, tools, and information to investors. They will charge more for their services than discount or online brokers. Online brokers vary considerably in the services offered, customer service, and commission fees. Know what you're looking for in a broker and research the broker's background before selecting one.[11]
  4. Pick stocks. Use the information you've gathered and the advice from your stockbroker to choose stocks. Understand that the data can be contradictory and confusing.

Tips

  • Refer to Benjamin Graham and David Dodd's book, "Security Analysis" for more information on fundamental analysis. Read Robert Edwards and John Magee's book, "Technical Analysis of Stock Trends," for a good overview on choosing stocks.
  • Warren Buffet and friends would get together every couple of years and ask each other the following question: "If you were marooned on a deserted island, and you could somehow invest all your money in one stock for ten years while you awaited rescue, what stock would it be?" Buffet says this scenario helps them to focus on long-term stock purchases rather than short gains and quick exits.
  • Do not buy a stock without seriously thinking about it first. Imagine buying a stock, only to see it fall 10% the next day. Would you think you had made a mistake, or would you still believe in the stock? Assuming you still believed in it, the drop in value would simply mean you now had the chance to buy more of it at a better price. Don't buy a stock in the first place unless you have that kind of confidence in it.

Warnings

  • Do not buy stocks on impulse. Buy only after in-depth research.
  • Don't place overnight orders. The stock might rise and open higher and you'll spend more money than you intended to.
  • Don't sell when a stock falls unless you're sure it's only going to drop further. Panic selling is a common pitfall in the markets and a major reason some investors lose money.

Related Articles

Sources and Citations

  1. ↑ http://www.investopedia.com/articles/stocks/08/recession-tips.asp
  2. ↑ http://www.bea.gov/national/index.htm#gdp
  3. ↑ http://www.whatiseconomics.org/macroeconomics
  4. ↑ http://www.investopedia.com/terms/m/macroeconomics.asp
  5. ↑ http://www.investopedia.com/terms/b/broad-basedindex.asp
  6. ↑ http://www.investopedia.com/university/stockpicking/stockpicking1.asp
  7. ↑ http://www.investorwords.com/2122/fundamental_analysis.html
  8. ↑ http://www.investopedia.com/university/technical/
  9. ↑ http://stockcharts.com/school/doku.php?id=chart_school:overview:technical_analysis
  10. ↑ http://www.investopedia.com/articles/active-trading/121014/best-technical-analysis-trading-software.asp
  11. ↑ http://www.investopedia.com/articles/00/112100.asp
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