So the stock lessons have been learnt, strategies have been drawn out, and broker accounts have been opened. Now the million dollar question is (literally), what stocks to buy? The following article outlines overall categories, industries and sectors to turn to when looking for stock ideas. The important thing to remember, however, is to always conduct your own in-depth research when purchasing stocks. In the stock market, luck eventually runs out and only those conducting research and doing their homework will succeed.
Stocks by Risk Level
When outlining your asset allocation strategy, you know that stocks place the highest above fixed-income securities and plain cash on the risk scale. However, within an equity investment, there are broad classifications, each with a complimentary respective risk level.
Blue Chips - Low Risk
Blue chip stocks, also known as large cap stocks, consist of some of the biggest companies in the world. They are often characterized by large market capitalizations and have reached a level of stability. They are not re-investing their earnings back into the company in hopes of rapid growth but rather are distributing their profits to their shareholders through dividends. These companies show signs of modest revenue growth and in turn, dividend yield. Although there have been a few blue chip companies that have gone south (think General Motors, Dell, Lehman Brothers) they are generally reliable companies for the modest investor, looking for equity exposure.
Where to find blue chip companies:
- Large banks (Wells Fargo, JP Morgan Chase, Bank of America, Citigroup)
- Telecommunications (Verizon, AT&T, Telus)
- Technology (Apple, Amazon, Facebook, Google, Microsoft)
- Food Products ( Coca-Cola, Kraft Foods)
- Energy (Exxon Mobil, Chevron)
Another popular method to purchase blue chip stocks is buying what you know. You may walk in to Wal-Mart and notice they have to open new cashes because they are so busy, a good signal to investigate Wal-Mart stock. You may have noticed that many of the items you just bought from the grocery store come from Procter and Gamble, a signal to investigate their stock. Be vigilant of your surrounding to notice potential investment opportunities and always understand the underlying company you are purchasing.
Income Stocks - Low Risk
The key characteristic with income stocks is that they offer a solid dividend yield, while being reliable companies to hold for the long term. A solid mixture of income stocks can provide an investor with significant passive income for years ahead and therefore is a crucial element to a portfolio. A big bonus with income stocks is the opportunity to set up a dividend reinvestment plan (DRIP) should that income not be needed in the short term. By setting up a DRIP on your account, you allow for the dividend distribution from the stock you own to automatically purchase more shares of that same stock. By doing so, you are effectively dollar cost averaging your position and compounding your growth, all without paying trading commissions.
Income stocks possess some characteristics that overlap with Blue Chips, as they are also strong companies more interested in distributing profits over a rapid growth. Real Estate Investment Trusts (REITs) can also make for good income stocks. In order to be considered a REIT, they are forced to pay out 90 percent of their taxable income to its shareholders as dividends, thereby offering large distributive yields. They also allow for exposure to the real estate market and provide an effective hedge against inflation.
Value Stocks - Medium Risk
Value stock investing is a popular method for evaluating stocks to buy. It involves quite a bit of fundamental research, but if done correctly, this strategy can yield strong returns while minimizing risk. The key to value investing is to find companies that are trading at discounts in relation to their intrinsic values. Value stocks can be identified through several characteristics (but not limited to):
- Low price-to-earnings ratios
- Low price-to-dividend ratios
- Low price-to-book ratios
- Low price-to-sales ratios
- Low price-to-cash flow ratios
There are no short cuts finding value stocks. They require input of time and effort along with plenty of patience. Investors must posses the ability to hold on to their value stocks for years at a time before the stock price reflects its true value. There are several resources you can turn to in order to find potential value stocks, however they should only be used as a starting point. Value stocks can be found through your own research using tools such as the Yahoo! Stock Screener, which allows you to input custom variables and metrics in order to find potentially undervalued stocks. Or, you can work with value investor professionals such as Value Stock Guide, an investment advice service specializing in deep research, stock selection and portfolio construction using a value investment process.
Growth Stocks - High Risk
For investors that can afford to take higher risks in exchange for higher returns, hunt for growth stocks. Growth stock investors look for companies at the early phases of development, with potential to grow exponentially. These companies are generally characterised with smaller market caps and high price-to-earnings ratios. Investors expect these companies to experience a significant growth in revenues and therefore bid up the price of the stock to higher earnings multiples. Growth stocks also tend to not pay dividends to investors as they reinvest their profits back into capital projects in hopes of expanding operations. Growth stocks are higher risk as they tend to be sensitive to news and earnings reports, with any slight negativity resulting in significant blows to share prices. However, should a company achieve its full growth potential, investors can see high returns.
Technology companies are typically good examples of growth stocks due to the relatively fast and easy scalability of their operations. IPOs also pertain significant potential for growth due to the possibility of "getting in early." One of the most popular growth stocks recently has been Elon Musk's Tesla, with a (large) market cap of $33B and P/E ratio of over 130, they are poised to seriously impact the electric vehicle industry.
With the consistent and rapid changes in growth industries, it is important to always keep a close eye on growth stocks investments, for optimal decision making. Check out Forbes list for potential growth stock ideas and always ensure you are studying and understand the company's story.
Penny Stocks - High Risk
Finally, for the adventurous investor looking for a thrilling ride, there are penny stocks. Aside from advanced trading techniques such as shorting and using options, penny stocks are the riskiest stock investment you can make. In fact, some do not even refer to penny stocks as investments but rather gambles. There are many different levels to purchasing penny stocks including how they trade, where to find them and what to watch out for, that we dedicated an entire starter guide to them. Bottom line, penny stocks are extremely volatile and risky investments. They are a popular target for pump and dump schemes, and have very little public information available. If you decide to invest in penny stocks, they should compose but a small fraction of your portfolio and only use money that won't cause serious financial damage if lost.
Before purchasing your first penny stock, ready up on how to find them and how to avoid stock scams.
Adding stocks to your portfolio is like baking a cake, it is important to have the right mix of ingredients for the best results. When you purchase a stock, understand the reason this stock has been added to your portfolio and set expectations for its performance based on the type of stock it is. Make sure that you focus on being a "buy and hold" investor rather like a trader approaching investments as gambles. Remember, it is crucial to have the right combination of stock types in order to maximize returns, minimize risk, and achieve your financial objectives.
Don't forget, never stop learning about the stock market and the best practices for investing in it. Continue your learning with related Wall Street Survivor beginner stock investing courses like Getting Started in the Stock Market, Creating Your Investment Strategy and Evaluating a Business.