If you have decided it’s time to invest in equities, you likely have many questions. The investment process can be intimidating and the amount of information available can be overwhelming. But not to worry, with a few starting points, you’ll be ready to ask the right questions and get looking for your next stock pick.
Whether you’ve been in the market for a while or are new to investing altogether, you may wonder how to pick companies to invest in? Is there any way to improve my odds of success while lowering my risk?
We’ve put together a list of ways on how to pick companies to invest in:
1. Identify Your Investment Goals
Before you pick any companies to invest in, make sure you identify your goals. Before you start scanning lists of stocks you might want to buy, it’s important to have a good handle on your investment goals.
Are you saving for something big in the near-term—a holiday or a down payment on a house? Are you more interested in saving for a longer-term goal, such as retirement? Your answers will help determine the nature of your investments.
2. Think Hard About Risk
When it comes to investing in stocks, it’s also important to have a handle on your risk tolerance. While everyone aims to make money through investments, you will need to decide if your main goal is more about wealth preservation, capital appreciation or income generation.
3. Plan to Diversify
Whether you consider yourself a more conservative investor or someone willing to accept a higher degree of risk for the potential of a greater payoff, you will still want to diversify within your portfolio.
Plan to have some blue chip, steady stocks, as well as those with higher growth potential. In addition, it is important to diversify across industries and sectors.
4. Invest in What You Love
When you are first on the lookout for stocks to buy, be sure to choose an industry you know and like. Within that space, look for companies whose story you understand and want to support.
Be sure to keep your personal bias in check; allow your understanding of a company to come from its origins, strategy and financial statements.
5. Keep on Top of Investment News
Once you have identified a handful of companies you’re interested in, follow their news – as well as industry and general news – closely. Being aware of lawsuits, regulatory issues or new market opportunities may help you decide if and when you want to invest in a given company.
Similarly, keeping on top of industry news may introduce you to promising business investment opportunities, or one you hadn’t previously considered.
6. Decide on Individual Stocks vs Mutual Funds
Many new investors will be directed towards mutual funds, as a way to get into the stock market with a lower degree of risk. By owning small amounts of many companies within an industry or under the guidance of a fund manager, you can avoid the risk that inherently comes with choosing a handful of individual stocks. The financial drawback is that mutual funds can be expensive. Most require you to pay a management fee to cover the overhead of the fund itself.
7. Get to Know P/E Ratios
If you’ve already started your investment research, you’ve likely heard of price-to-earnings ratios (P/E ratios). The P/E ratio is usually shown as part of stock’s basic market summary information. It measures a company’s current share price, relative to its current per-share earnings.
In other words, it allows investors to compare one company easily to another with a tool that measures stock price to earnings. A higher P/E ratio could indicate that either the company is over-valued or that investors expect high growth.
8. Understand Why Cash is King
When it comes to investigating stocks, don’t be afraid to do a bit of digging. Public companies have financial statements readily available; it is important to find out how much cash a company has on hand to fully understand its overall well-being.
Cash is especially important to companies with seasonal income or in times of financial distress. Companies need cash to buy their raw materials, to pay employees and otherwise keep business flowing. Look for positive cash flow to indicate a company is in good health.
9. Pick a Plan and Stick to It
No matter which approach you decide upon—whether you decide to invest in a handful of individual companies or to spread your risk through a mutual fund, allow yourself the time to stick with a strategy for a period. Buying and selling stocks can be both expensive and risky.
If you are wondering how to pick companies to invest in, you will first need to identify your goals and understand your risk tolerance. You may consider hiring a professional to give you guidance, but perhaps you have enough confidence to try your hand at research and stock selection yourself. Whichever approach you decide upon, it is important to start with a thorough research.