Though investors may find it easier to build a diverse portfolio using exchange-traded funds (ETFs) or mutual funds, investing small amounts in individual stocks can be a good way to learn the intricacies of the market. However, it usually isn’t enough to just throw your money into the market — you’ll need to do some research first.
If you invest your money strategically using a method that works for you, you could minimize your risk and maybe even earn higher returns. Here are some steps to take as you learn how to research stocks before choosing which ones to invest in.
How to research stocks: 5 steps to follow
- Understand the different types of stock analysis
- Dig into the company’s reports
- Consult with your brokerage firm or other research tools
- Make sure you understand the basics of the company
- Conduct qualitative research
1. Understand the different types of stock analysis
Before diving into the actual research of a particular stock, you’ll want to understand the different types of stock analysis, what they consist of and which route is best for you. In general, there are two broad categories of stock analysis:
- Fundamental analysis: This type of stock analysis aims to determine whether the current price of the company accurately reflects its future value. It involves researching the nitty-gritty financials of the company, and can include looking at factors like earnings per share, the price-to-earnings ratio and more.
- Technical analysis: This type of analysis utilizes data based on market activity, like trading volume and prices, to try to determine what comes next for a company’s stock price. Typically, investors doing a technical analysis will use tools, charts and trends to try and predict future price movements.
This article generally focuses on aspects associated with fundamental analysis, as it is used more for long-term investments, while technical analysis typically is used more for short-term trading.
2. Dig into the company’s reports
Every publicly traded company is required to publish reports. Using that information, investors are able to find companies that align with their investment interests. If investors did not have access to this information, they would be unable to make educated decisions about their investments.
To find these reports, you can look at each company’s website — many have special pages for investors. You also can search the U.S. Securities and Exchange Commission’s (SEC) filing database, EDGAR, if you have difficulty finding the reports in other places.
Some of the most informative reports include the following:
- 10-K: This form is filed annually with the SEC and contains financial statements that have been audited by an independent third party. It’s a comprehensive form that will show you almost everything you need to know about a company. In it, you can find financial data for the past five years, information about how the company earns money, risk factors the company faces and a discussion about the company by management.
- 10-Q: Through this form, which is filed quarterly, you will gain access to unaudited financial statements. It’s less comprehensive than the 10-K form, but still a worthwhile tool for investors. In addition to quarterly financial statements, you will gain access to management discussions about the company as well as information about potential market risks, legal proceedings, some internal controls and any unregistered sales of equity securities.
Once you find the above forms, you’ll need to locate the pertinent information. Each form has an overwhelming amount of data, but if you know what you are looking for, it should not seem as daunting. Here’s some of the most important information for investors to look for:
- Net income: Check to see if the company finished with a gain or a loss at the end of the period. You can find this number at the bottom of the income statement. It equals total revenue minus expenses, depreciation, taxes and more.
- Price-to-earnings (P/E) ratio: The P/E ratio is calculated by dividing the market value of a share by the earnings per share. Although the ratio often is calculated based on how the stock has performed in the past, it can show you how the market thinks this stock will perform in the future. If a company has a relatively high P/E ratio, it could indicate that the market expects healthy growth in the near future. Compare the company’s ratio to others in the industry to understand where this company stands against its competition.
- Return on equity: The company’s return on equity helps you better understand how effectively the company uses its investors’ money and returns investments to its shareholders.
This is not a comprehensive list of factors to measure a company’s potential for financial success, but it is a good place to start. Remember — a single number will not be able to determine the worth of a company. You need to consider a variety of factors before deciding.Find a Financial Advisor
3. Consult with your brokerage firm or other research tools
If you have opened a brokerage account, utilize the resources that come with it. Most brokerage firms offer tools to help you research stocks. Whether the firm offers in-depth reports or a database of information, take advantage of those resources.
Additionally, you may have access to a qualified broker through your account. It may be a good idea to ask their opinion about a potential stock purchase.
If your brokerage firm doesn’t offer any useful options for researching stocks, you still have access to sites like Yahoo Finance, which provides investment news and customizable stock screeners.
4. Make sure you understand the basics of the company
In addition to understanding the financial statements of a company, you should understand how it works. Make sure you know where the revenue comes from. Does it come directly from consumer sales, advertising revenue or elsewhere? Who are the company’s biggest customers?
It’s also important to look at the basics of the industry the company operates in and how the company fits into it. Is it an established giant or a young company trying something new? Are there regulatory issues the industry must overcome? Think about how the company will fit into the future of the industry. Will it be able to adapt to change, or will it fall behind its peers? Does it have any competitive advantages?
5. Conduct qualitative research
While the financials of the company are an essential component to the research, so is qualitative research, which is a less quantifiable evaluation of a company’s caliber. While part of your qualitative research might include looking at some of the factors outlined in the step above, it can also include looking at factors such as:
- Leadership: A company cannot function without upper-level management at the helm. You can usually find the names and roles of the leadership team on the company’s website. Once you find the leaders, look them up. Don’t just read the company’s short descriptions — search for their names. You may be able to find out more about their backgrounds and management styles. It’s possible that the past actions of these leaders will reflect their future choices. Ensure that you’re comfortable with the management in charge of increasing your investment’s worth.
- Company values: Even if everything looks great so far, stop and think about the values and ethics of the company. Look up their mission statement and business practices. Then, read news reports to make sure the company’s actions match its claims. If you disagree with what the company stands for or how it conducts itself, you may want to reconsider your investment. The money you invest might help further a cause you don’t agree with, so make sure you’re comfortable before you invest.