Buying Stocks 101

Sometimes the world of investing can seem daunting.  Covered calls, put options, derivatives, commodity futures: it often feels like a PH.D. is required just to play the game.  But the truth of the matter is that most of that stuff doesn’t matter.  Well, it matters a little, but not as much as the foundation of investing since the first corporation was born - trading shares of stock for profit.  People often get sidetracked by the hot new investment strategy that the money shows are promoting this week, but that is often driven more by ratings and viewership than by time-proven investment strategy.  Buying stocks low and selling them for a healthy gain is not a fad - it is the essence of investing.

But how does one identify a good stock to buy?

Value Investing

Before so many alternative investment methods took the stage, the core principle preached to the masses was invest for value.  That is the principle that Warren Buffet used to amass his fortune, and it is one that you should apply to your portfolio before any other.  Value investing simply means to look for stocks that are performing better than their peers in key areas, such as earnings and sales, but is trading lower than the value of the company and its assets.  Essentially, you want to trade shares of stock that are undervalued, meaning the stock price is lower than what the company fundamentals suggest it should be.  You are buying stocks at bargain prices, and reaping the gains as the market begins to recognize their true worth.

Is the Company Healthy?

Even if the stock looks like a good buy, you still need to go over the company fundamentals to make sure its healthy.  The companies public financial documents, press releases, and other data help you formulate a picture of the companies health.  The price-to-earnings ratio is a key indicator as to the value of the stock, and whether the company is trading high or low compared to what it is bringing in.  The industry the company serves, it’s current market position, and the general prospect of the products it sells are also import factors to consider.  Many people trade shares without understanding the data behind them to their detriment.

How is it Positioned?

Also important are more esoteric factors like how the company is positioned in the marketplace and how strong its brand is at the moment.  Does the company occupy a niche that is serves better than anyone else?  Is it well-established?  How hard is it for another company to enter the market?  Are they putting any money into research and development?  If you were buying a business, you would certainly consider these questions.  Why should it be any different when buying stocks?

Who’s Investing in it?

This one is a bit more difficult to discover but it is vital none-the-less.  You can find a great stock that meets all of the points we have already covered, and it take years before it makes you any real money.  Why?  Because other people aren’t buying it also.  You may have discovered a gem before many other people did, that’s great!  But you eventually want people to discover it so they can drive the price up, making you money.  How can you trade shares of stock for profit if no one is trading that stock but you?  That is a bit of an over-simplification, but you get the point.  Check to see if mutual funds or pension plans are starting to buy that stock.  Look for write ups in newsletters or market analysts beginning to highlight its value.  This is tricky because you don’t want to buy too early, but you also don’t want to buy too late.  You want to ride the wave as it’s building not as it’s about to crest or before you are sure it will actually turn into a wave.

This entry was posted on Tuesday, October 6th, 2009 at 4:02 am and is filed under Basics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.