Investing in stocks is one of the best ways to build wealth, especially considering that stocks beat most other types of investments in the long term. There are many ways to pick a stock; you can guess, check trending investments, or even let someone else do the choosing for you. However, none of these methods are likely to help you pick a winning stock. In this article, we will look at some helpful tips to help you pick the best stocks.
Determine Your Investment Goals
Every investor is looking to accomplish something different with their investments. Younger investors are likely looking to build wealth for their retirement or other future investments, whereas older investors may be interested in capital preservation so they can enjoy their retirement comfortably. Some investors may be interested in getting a regular passive income from their investments through dividends and other types of cash distributions.
Investors looking for capital appreciation will invest in stocks, assets and other investment vehicles that will grow into the future. These investors may consider riskier investments as long as they can receive a higher return on their investments.
Income-oriented investors are more interested in buying and holding stocks that have regular cash distributions such as dividends. Many of the companies that fit this description are low-growth and mature companies that can afford to offload some of their profits as dividends. Other options for these types of investments for income-oriented investors include bonds and real estate investment trust.
Finally, we have investors who are concerned with capital or wealth preservation. These investors try to avoid investment risks as much as they can. Because of this, their best investment options are in blue-chip companies that tend to do well regardless of market conditions. These are mainly companies that provide products and services we need every day, such as those manufacturing consumer staples, tech companies or even companies in the health sector.
Determining the type of investor you are will play a significant role in helping you determine which types of stocks and investments would work best for you.
Find Companies You Can Understand and Enjoy Investing In
Buying stocks is essentially buying a part of a company or business. Because you will be a partial business owner, even if it is for a small portion of the company, understanding the companies you decide to invest in before you do so will reduce the chances of failure.
The best place to start is to look at the products and services you use frequently. Take a moment to consider if you would be willing to invest in them. Another angle is considering companies that impact your life the most. For example, if you use certain medications that improve your quality of life, you might consider investing in the company behind the drug.
Once you have a list of companies you would be interested in investing in, you can move on to researching the company.
Determine If a Company Has a Competitive Edge
Now that you have a list of companies whose stocks you would like to buy, start narrowing them down. The first step is to see whether the company has a competitive advantage. A company with a competitive advantage affects society, attracts interest and keeps growing.
In addition to having a competitive advantage, try to find out if it is sustainable. When you look at a company like Ford, it has the competitive advantage of manufacturing arguably the best trucks in the United States. This competitive advantage is sustainable because they do not have clear competitors and there are no competing products (trucks) coming to the market soon.
Some of the factors to consider when looking for a competitive advantage include unique brands and their placement, scale, the network effect and the intellectual property the company holds.
Determining the Value of the Shares
Determining the fair value of a company’s shares tells you whether the stocks are a good value to buy. There are various metrics that you can use, the first one being the price to earnings ratio. This is the price of a single share divided by the earnings per share the company holds. When the price-to-earnings ratio falls below traditional levels, that means the company is doing well and its shares are of great value. This is an important metric for companies that are seeing a steady increase in their revenues and enjoying growth.
If you are looking to invest in growth stocks (stocks of rapidly growing companies), you need to check the price per sales ratio. This is the ratio of the share price to the sales made by the company. If you decide to use this metric, also check the products the company has released recently. A company’s revenue may be impacted by the sales from a new product and so investors have to also think about the future revenue that can be generated by this product.
The dividend yield is a very important metric. This is the ratio of dividend paid out to the single share price represented as a percentage. A higher dividend yield means the company shares are trading at a fair price and would therefore be a great investment. Be sure to also check dividend growth to see the increase in the dividend yield over the years.
Check How a Company Treats Its Dividends
Investing in companies that pay a dividend is a smart investment strategy, but you need to look beyond whether a company pays a dividend and at how the company treats the dividend. Mature, stable companies will often offer a sizable dividend, usually at over 5% of the single share price. The best companies have also been paying dividends consistently for years, with many often increasing their dividends over the years.
This means that in addition to getting a dividend when you invest, the dividend amount will continue increasing every payment period, which can be a huge advantage for those who chose to reinvest their dividend. To get started investing in stable, mature companies, do check out the selection of high dividend stocks put together by WealthSimple.
These stocks have been selected because their companies have a history of growth and dividend stability. In addition to helping you with their high dividend stocks selection, WealthSimple also helps you get started through their WealthSimple Invest tool and a free stock when you sign up. If you have any issues or need help getting started, you can also get in touch with their team of financial advisors who are always standing by to answer any questions you might have.
When selecting dividend stocks, be wary of companies that have an unusually high dividend yield. This usually means one of two things; the company’s stocks have fallen, and the dividend payout has not been adjusted, or the company is getting desperate. Either way, a high dividend yield does not necessarily mean the company is doing well and additional research is required to know what is going on.
It is also understandable for businesses to temporarily reduce their dividends or cut them altogether. This can happen when the market swings downwards. However, when it goes on for more than a few quarters, which is an indication that the company might be struggling and so an exit is perfectly reasonable.
Try to Find Some Margin of Safety
The best stocks are deemed to be those that are trading below the estimated fair price. For example, investors have a margin of safety when a stock is trading at $70, but experts estimate its fair value to be $80. By going for shares trading below the fair price you have calculated, you will be saving yourself from huge losses if your valuation calculations are wrong. If the calculations are right, then the stock will see growth up to at least the fair value you have calculated, and you still win.
Investors should aim for a 10% margin of safety for common stocks. For a growth stock, where many factors can impact the share price, it would be better to go with a 15% margin of safety. Such a large margin of safety protects you when a larger company enters the market or the company faces an unprecedented challenge, for example, because you bought the shares at a great value.
Also, avoid going for the lowest price possible. You might have to wait for a long time before the share price falls to its lowest. The best thing you can do is trust your calculations are correct and buy the shares when they hit the value you have calculated.
Investing in stocks is a great way to build a sustainable and profitable investment portfolio but picking the right stocks can be challenging for a lot of people. Fortunately, there are a lot of tools and resources to help investors do their research and find out if the shares they are interested in are worth buying. Understanding the companies that you are interested in as well as how to calculate the fair share price will go a long way in helping you make these determinations.