Do you feel that you have attempted to invest in the stock market only to feel disappointed and frustrated with yourself? You may even have tried to research your investments and you still lost money. It is very common to underestimate the amount of research that is required when selecting stocks to invest in. Many people would come to the conclusion that you aren’t spending enough time researching.
However, do you fully understand what to research?
Narrow Focus
In an article called How to Research Stocks by Dayana Yochim on nerwallet.com she emphasises the importance of narrowing your focus. There are a ton of financial reports, news articles and different opinions out there. It is impossible for you to take all of them into account when you are researching stocks.
Instead you should focus on the revenue, net income, earnings, earnings per share and price to earnings ratio, and return on equity.
Revenue: Revenue is defined as the amount of money a company earned during a part of the year for example Q1. It is often the very first thing you see on the income statement and it is often labelled as the top line.
On some occasions the revenue is broken down into what is referred to as operating revenue. This comes from activities central to the company. Nonoperating revenue comes from one time things for example the sale of a building owned by the business.
Net income:
Another factor you should research is the net income of a company.
This can be found at the very end of the income statement put out by the business. The net income is the total amount of money the company has generated after they have paid their operating expenses. Such as taxes, and asset devaluation.
Earnings and earnings per share:
When you divide the amount of earnings by the amount of shares that are available to be traded you are left with earnings per share. This number shows how profitable a business is on a per share basis. This makes the business you’re considering purchasing shares in easier to compare against other businesses.
Return on equity:
The return on equity shows you how much profit a business generates from each dollar investors have invested with them. Be vary of the fact that return of equity can be increased by the company when they repurchase shares. They do this to reduce the shareholder equity denominator. Shareholder equity denominator is defined as the difference between a company’s assets and liabilities.
Look beyond the Numbers
According to comsec.com It is crucial to study other things than the numbers a company puts out. Look at what branch the company is active in and how big they are in that particular market. When a company is listed on the stock exchange they are required by law to keep their shareholders and investors in general up to date. This means that they keep investors appraised about any changes of goals, developments that could impact investors and the same goes for acquisitions.
You should also consider these factors before investing in the company:
- Does the company have an advantage over their competitors?
- Is it easy for competitors to enter the same industry?
- Are there any instances or economic factors that could impact the company?
- Does the company provide a product or service that is easy to substitute?
- Do the customers or clients have a lot of power regarding prices on products or services?
Understand the two types of stock analysis
The Motley Fool states in a similar article that it is very important to understand the main two types of stock analysis.
Fundamental analysis:
This method of analysing is based on the assumption that the stock price isn’t reflecting the real value of the company. This is a tool that investors use to discover the best opportunities to invest in. Valuation metrics and other facts are being taken into account to determine if a stock is priced at an attractive price decided by the investor.
Technical Analysis:
Technical analysis is a method that is used when the investor believes that the price of the stock is reflective of all the information available. The most important distinction from fundamental analysis is that this method is intended to find long term investments.
Qualitative Research
In the same article that I referred to previously by Diana Yochim called How to Research Stocks she emphasised the importance of qualitative research. This type of research has the ability to reveal all the black and white financials of a business historically. Qualitative stock research helps the investor find the true picture of how a business operates.
Warren Buffet backed this up by saying “ Buy into a company because you want to own it, not because you want the stock to go up.” That’s because when you buy stocks, you purchase a personal stake in a business.”
The questions that you should be asking yourself before purchasing shares in a company are:
How does the company make money?
On occasion it is easy to find out how a business generates its money, for example a retail store makes money by selling clothes. Other times it is very difficult to understand how a business makes money.
For example fast food companies don’t make the most money from selling food. They make the most money from selling franchises. Buffet uses a rule he calls the rule of thumb: “invest in common sense companies that you truly understand.”
Does the company have a competitive advantage?
What you should look for is a business that stands out from everyone else. It should be difficult to imitate, copy or overtake. The competitive advantage could be the company’s brand, business model, innovative ability or research capabilities. The harder it is for other companies to emulate the company, the stronger it´s competitive advantage.
How good is the management team?
A business is only as good as its leadership is a phrase that has been uttered many times. The leader or leaders need to be able to steer the ship and steer it in the right direction. To find out about the management you need to read the words of the leader or leaders.
You also need to check out the annual reports to find out how good the leader or leaders are at making the right decisions to make the company money. Be very sceptical of boards made up of insiders that have made their bones only at the company. Healthy independent thinkers are crucial and if they are not present at board meetings or members of the board the company is in trouble.
What could go wrong?
What we are talking about here are fundamental changes that affect a company’s ability to expand. For example when scenarios occur you need a good management team to weather the storm. When an important patent on one of the companies products expires the ceo needs to start taking the business in a new direction. This is crucial for the company’s survival!
Summary
Investing in stocks is not a simple task, and it requires a significant amount of research before buying any shares. It is not just about reading financial reports and news articles, but understanding what to look for in them. Revenue, net income, earnings per share, and return on equity are important factors to consider when selecting stocks to invest in.
Investors must also understand the two types of stock analysis: fundamental analysis and technical analysis. Besides, it is crucial to study other aspects such as the industry and market the company operates in, the competitors, the economic factors that could impact the company, and the company’s ability to substitute its products or services.
Apart from quantitative research, qualitative research is also essential. Investors should ask themselves questions such as how the company generates its revenue and whether it has a competitive advantage.
The harder it is for other companies to imitate a business, the stronger its competitive advantage. Another important factor is the management team, which should be capable of steering the business in the right direction.
Ultimately, investing in stocks is not just about buying shares of a company because they seem profitable. It is about buying shares in a company that you want to own and that you truly understand.
As Warren Buffet once said, “Buy into a company because you want to own it, not because you want the stock to go up.” Therefore, investors should take their time to research the companies they are interested in and make an informed decision based on both quantitative and qualitative research.
By doing so, they can increase their chances of making successful investments and avoid feeling disappointed or frustrated with their investment decisions.
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