So you’ve thought about investing in the markets, but you’re not sure how to find the best stocks to buy. Don’t feel bad, you’re not alone. The only catch is that this is not the easiest thing to do either. There are thousands of people who lose money in the stock market today – and quite honestly, that’s the case every single day. Many of them bring this on themselves and commit lots of little mistakes that can add up to really big losses over time.
The good news is that virtually any investor can greatly increase their odds of making money in the stock market. And this can be accomplished mostly by exercising both common sense and using some basic tools that are available to everyone. The sad thing is that there are lots of people out there who are unaware of these simple tools. In many cases, just a few simple little things could have saved stock investors thousands of dollars.
It is our goal here to not only help those who are interested in finding good stocks to invest in, but also help them find the best stocks to buy. Kind in mind that one of the ways that will help our stock picks is by learning from the mistakes of others too.
Defining Your Stock Investing Objectives
Believe it or not, not knowing why they are investing in stocks is a huge reason why investors lose money in the stock markets. This is the case with virtually all markets like the New York Stock Exchange, the NASDAQ, the Dow Jones stocks, FTSE100 stocks, the World stock markets, you name it.
Many of these people simply open up an account with their stock broker – often times an online stock broker in today’s environment – and start buying stocks. They have failed to ask themselves some very basic questions. What kinds of questions, you ask?
To begin with, are you trying to grow wealth over a period of time? Or are you trying to make a big score on a “hot stock” or a “hot tip”?
The way you answer these two questions should determine which stocks you be considering. Sadly, a common occurrence in the markets is that even when investors do have an objective, they are buying stocks which don’t even match that objective.
One of the most common reasons for people to invest in stocks is that they gotten a “tip” from someone. And it’s shocking that often times, that someone is not a financial expert and knows very little about the stock markets. They probably have repeated something they have somewhere else. I like to ask this simple question. Would you ask this same person about a health ailment that you are suffering from? I should say not – therefore, you shouldn’t take financial advice from them either.
Understanding the Different Types of Stocks
We mentioned this topic briefly in the last section when we referred to finding stocks that meet specific objectives. If you are going to invest in stocks, then you have to understand how they are grouped and how they are categorized. More importantly, you need to have a feel for how stock in particular categories – stock gurus call them “sectors” – generally behave. In the end, there are two basic types of stocks.
Growth Stocks – these are stocks that are poised to take off in the near future. Their parameters and usually their technical analytics indicate a strong move is forth coming. The most prominent of these parameters is the stock price itself – price action is observed on a stock graph or stock chart.
When reviewing these charts, technicians look for certain patterns that have repeated itself in the past over and over again. These repeatable patterns reveal to them what kind of stock move is coming and they buy or sell accordingly. They typically don’t pay as much attention to stock market news as they feel such things are already indicated in the price action on the chart.
Undervalued Stocks – or simply called value stocks, these are the ones that are priced at bargain prices. Investors who buy these pay more attention to “fundamentals” than “technicals” like stock charts. Fundamentals are things like stock market news, company news, new executive hires, mergers, sell-outs, wars, storms, etc.
Often times, a company in a strong sector may get an unexpected court ruling against them or perhaps news of internal corruption and it drives the entire sector down in the stock market. There would be many companies in that sector who still have strong fundamentals (and even technicals too). This might be a scenario where value investors would swoop in and buy up their underpriced stocks.
One last thing to mention about stock types – and this is a very important thing to consider. What I’m talking about is the time element. Technical investors or traders are usually looking to turn a certain profit fairly quickly. The reason is they feel their capital needs to be earning a return of some sort. A portfolio that is tied up in dead stocks is costing them the opportunity to put that capital into something that is earning a return. This is called “opportunity cost” and technical stock traders are very aware of this factor.
Value investors are generally geared to wait it out. If they have found a true bargain in the markets, then it might take as much as a year or two for that potential profit to be realized.
The time element of stock market investing is something that every investor has to ask themselves.
Using the Right Stock Investing Approach
When I first started finding good stocks to invest in, one of the first amazing things I ever read was a piece about professional investors versus new inexperienced investors. The article simply stated that professional investors could pick stocks by literally throwing darts and still make more money than an inexperienced investor who carefully selected which stocks to buy.
The take home message of this article was that professionals knew how to manage trades and understood the principles of money management far better than new investors did. Furthermore, earning profits in the stock market was more the result of managing stock positions after you bought them, than it was which stocks you chose to purchase.
I thought this article was total hogwash for a few years after reading it. However, I came to learn that it was completely true. Over the following years, I observed countless times where a variety of stock investors bought the exact same stock at the exact same price – but their ensuing profits were all over the place. There were always a few that lost money, and a few that earned lots of money. I realized that the only difference between them was how they managed their stock positions.
Understanding is critical to all investors. Not only that, knowing your objective (like we mentioned earlier) is even more important. I have learned that know when to sell a stock is a far more bigger decision than knowing when to buy one.
Understanding What is Really Important in Stock Investing
If you want to learn to perform solid stock analysis and find the best stocks to buy, then I believe you should be evaluating stock by its fundamentals and its technicals. US stocks in recent years has become more volatile than ever before. This increased volatility makes it very hard to buy a nice blue chip stock from a solid company and hold it for years. Even the biggest companies have become risky at times.
To earn stock market profits now, your stock portfolio has to be managed more actively. Sure, you could hire someone to do it for you, but they will get part of your profit – is that what you really want?
As you put together a group of stocks, you need to understand these concepts for stock portfolios:
1 – More stocks in your portfolio = less risk, less potential profit
2 – Less stock in your portfolio = more risk, more potential profit
3 – Protect entire portfolio = cutting losses at every opportunity
Professional stock investors will tell you every time that protecting your investment capital is far more important than earning profits. This is because if you have no capital, there will be no profits – period.
Stock traders at every level often talk about the one or two trades that made their entire month or year. In other words, they kept cutting losing trades, kept taking small profits here and there – pretty much breaking even – until the one big trade came along. You will hear many professional poker players say the same thing – one big hand or two makes their entire night.
The Importance of Stock Market Emotions
Another critical factor in investing in stocks pertains to the careful timing of purchasing and selling decisions. We often hear professional market investors talk about buying weakness and selling strength. In simpler terms, that means buying stocks on pullbacks in stock price and selling when stock prices are surging. Inexperienced investors tend to do the exact opposite and this is mainly because they are reacting emotionally.
Again, this gives us yet another reason for having an investing objective. When we know in advance when we will sell to take profits or to cut losses, we can then make those decisions logically without emotions. Never forget that emotions will bankrupt your stock brokerage account.
When stock investors have taken the time to find the best stocks to buy, and then they panic and sell them without a rational reason – they are demonstrating no faith in the reasons for buying the stocks in the first place. Investors must have a solid system for buying and selling which gives them an edge.
Yet another point to make in dealing with market emotions is dealing with stocks whose characteristics match our personality. For instance, if you’d rather buy a few stocks and give them time to grow a profit for you, then you really shouldn’t be considering stocks that tend to be volatile. On the other hand, if you enjoy turning quick profits and get bored by conservative blue chip stocks, then volatile stocks are probably exactly what you are looking for.
Evaluating the Best Stocks to Buy
Regardless of your stock type selection and your emotional preference, you will need a good stock screener or stock picking system that provides you with health stocks to choose from.
The best stocks to buy will always have many of the same elements. To begin with, they will have a record of good earnings. I usually like to see a string of positive earnings reports – in fact, I like to see about 3 years of them.
Secondly, you should be looking at stocks from healthy sectors. I don’t care how strong a company is – it will not withstand negative pressure on the entire sector. Do yourself a favour and stick to those in healthy sectors.
Pay attention to the price to earnings ratio (P/E ratio) for all stocks you consider. The P/E ratio will instantly tell you how inflated the stock price is compared to other stocks. This is important because when the stock market drops, the biggest drops always occur with stock having the highest P/E ratios. Higher P/E ratio stocks are always more volatile.
I have heard professional traders say they won’t buy a stock with a P/E higher than 40. And then I’ve heard others say that look for P/E’s of 100 or more – because these are the stocks that are “hot”.
Let me illustrate how the P/E ratio works with an example. The equation for the P/E is simply:
Price/Earnings = Stock Price (divided by) Year’s Earnings
Let’s say Stock A and Stock B both earned $1.00 per share for a given year. However Stock A is trading at $23 per share and Stock B is trading at $150 per share. Their P/E ratios are then calculated as such:
P/E of Stock A = $23/$1 = 23
P/E of Stock B = $150/$1 = 150
Bear in mind that BOTH STOCKS are earning the same – but people are paying more for Stock B!
During the Dot Com boom of the late 1990s, we saw tech stocks with P/E ratios of 400 or more.
The positive factor of the P/E ratio is that stocks that are losing money HAVE NO P/E ratio.
Conclusion
Hopefully, you are now aware of some of the critical factors that pertain to finding the best stocks to buy. As you can see, most of these factors aren’t rocket science, and anyone can practice solid principles when investing in stocks. In fact, many of them only require that you be aware of them.