The hardest bit about stock trading for greenhorns is identifying the appropriate companies to buy stock in. It is a lot like looking for a car to buy. You have to consider the technical specs of the car, the opinions of past and current users of the model, and the reputation of the manufacturer. For traders, this is called fundamental analysis and it involves scrutinizing a company’s financials, competition, leadership and a range other factors to determine if a stock is worthy of a place in your portfolio. Read on for four easy steps to finding the best stocks to buy.
Step #1. Create a List of Prospective Companies
Select all the companies you would like to invest in and put them in a list. You could base your choices on any set of factors, but it is wise to choose established companies in industries you are familiar with or have an interest in. Create a list of at least 10 and not more than 20 companies and get on with your filter-down procedure.
Step #2. Find Important Stock Research Documents
Start by reviewing the financials of each company separately. This is referred to as the quantitative research phase, and it involves finding and going through official documents that companies are supposed to file with the SEC. The two most important forms are:
- SEC Form 10-Q: A report on a company’s financial position and performance that must be submitted quarterly to the SEC.
- Form 10-K: This is a report submitted annually to the SEC containing a set of audited financial statements, which include the balance sheet, the company’s income sources, and documents showing how it has handled its revenues, cash, and expenses over the past financial year.
If you don’t have the time to find and review all important documents of all the companies in your list of options, you can find the filings simplified in brokerage websites. If you don’t have a trading broker either, consider visiting dedicated review sites such as www.trusted-broker-reviews.com for some of the highest rated brokers in the industry.
Step #3. Focus on Specific Aspects
Financial reports hold tons of numbers and details about a company, and aspiring investors may struggle reviewing all their options. Here are the most important things to focus on:
- Revenue: This refers to the money received by a company during a financial period. It is sometimes called the “top line” because it appears first on a company’s income statement. Check the figures against both the “non-operating revenue” and the “operating revenue”, if those sections exist. Operating revenue refers to money that comes from daily business transactions while non-operating revenue is the money from one-time transactions such as asset sales.
- Net income: Also, known as the “bottom line”, net income appears at the bottom of the financial statement. It is the figure that is arrived at after subtracting depreciation, taxes, and operating expenses from a company’s total revenue.
- Earnings per share (EPS): EPS is what you get when you divide a company’s income by the total number of shares. This is the best aspect to use when comparing a company with other investment alternatives.
Step #4. Conduct Qualitative Research
Qualitative research gives you useful insights into the operations of a business and the chances of its stock going up. Look to understand the following:
- How the company makes its money: Companies make money differently, and some such as sports franchises do not have obvious income channels. Always consider “common-sense” businesses, whose operations you have a nodding acquaintance with.
- The element that gives the company a competitive advantage: Find that thing that gives the company the edge on its rivals. It could be anything from patent ownership and research capabilities to monopoly powers and scale. Competitive advantage is determined by these factors, and the harder it is for competitors to access them, the likelier it is that the company’s success will be long-lived.
- The risks that the company faces: Look at the foreseeable changes in the market and company’s structure that may take a toll on its success in the long run. Sometimes a patent is nearing its expiry or there is a new rival company on the rise. Be sure to understand the company’s state and everything that could go wrong on the way before investing.
There are many documents and research resources that can help you find a suitable company to invest in, but the most important thing is being able to see what the future has in store for the company. That is what separates the good from the great when it comes to stock trading. The above tips can help you narrow down your list of options to that one company that truly suits your interests. From there, try to understand the company better by reading financial journals, browsing the internet, and consulting experts before committing.
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