How to Pick Stocks

How to Pick Stocks

If you have come across this article, you are likely planning to get some money in the bank.

But who isn’t?

Everyone wants money, but few know how to get money.

The best way to get money is through investing.

People invest money to create wealth in the future.

Investing can be stressful (if you let it be), but the rewards are totally worthwhile.

For example, by investing in the stock market, you will have more money for things like:

  • Retirement
  • Education
  • Fun

Who doesn’t want more of those things?

Additionally, you can use your newfound riches to care for family, friends, and most importantly, yourself!

So, whether you are in the process of saving or have a couple thousand dollars tucked away…

…you will need to understand how to build your investment portfolio.

But where do you start?

Know Your Goals

First, you must know your goals.

For example, what will your money go toward?

This step is essential because your goals will largely determine your investing strategy.

Therefore, it is critical to determine your goals and define the purpose of your investment portfolio.

You can start by getting a better idea of your risk tolerance.

Know Your Risk Tolerance

What is your risk tolerance?

Here is an example:

  • Investors with a low risk tolerance are more concerned with capital preservation.
  • Investors with a high risk tolerance are more concerned with capital appreciation.

Those with long-term investing goals generally have a higher risk tolerance. However, risk tolerance is also determined by personal preference (i.e., can you stomach market fluctuations?).

If you can withstand market fluctuations, you should invest in a range of market caps – from small to large.

If you need to preserve capital, stick with large, stable, blue-chip corporations.

But keep in mind – the more risk you can tolerate, the higher return you are likely to earn.

Compound Interest

So, how much money can you make in the stock market?

Let’s see an example:

Say you take $5,000 of your savings and invest in the stock market.

Assuming an average 8% return, your $5,000 would turn into $50,313.28 over the span of 30 years.

Now that is not a bad return for doing nothing.

This is compound interest at its best!

In fact, Albert Einstein is said to have said:

“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”

However, you are unlikely to see 8%+ returns while “playing it safe.”

If you have 30 years to spare, you can (and should) be more aggressive with your investments.

If you do not have money to invest, consider savings strategies to create savings.

To accomplish this, simply implement small changes that add up in significant ways.

For example, I decided to start bringing lunch from home (save $100/mo.), cut cable (save $50/mo.), and avoid Starbucks ($100/mo.) to create extra savings.

Those small lifestyle changes created an additional $3,000 in savings per year for me.

Bottom line: Do not say that you CAN’T save money because it usually is very possible.

No matter what you do – you want to avoid doing nothing because that will guarantee a lesser lifestyle.

Know What to Avoid

Here are some other things to avoid when investing:

  • Starting late. You may begin to invest But there is no denying that the earlier you start, the better off you will be in the future.
  • Investing before paying down debt. If your interest rate is above 5% – pay it off. While investing in the stock market can result in higher returns, paying off debt will result in an instant 5%+ return on investment.
  • Investing for the short-term. If you are saving for a short-term goal (i.e., a car), you should probably avoid the stock market. You will be subject to market volatility in the short-term, and this could be detrimental to your goals. Consider money market funds or CDs instead.
  • Passing up free money. When your company offers a 401(k) match – you take the money – no exceptions.
  • Playing it too safe. If you are young, you need to be in the stock market. You can withstand the market volatility because you (unfortunately) have many years of work ahead of you before retirement.

At this point, I believe you are ready to start building your portfolio.

To recap, what have we learned in this section?

You should now understand:

  • Why you should invest;
  • The powers of compound interest; and
  • Common investing pitfalls.

However, these items are the easy part of investing.

Deciding what stocks to purchase is where things get a little tricky.

Keep in mind – there is no “right” way to go about this process. However, some basic tips can keep you on the right track.

We are here to show those tips and tricks today! Are you ready to pick stocks and build your portfolio?

How to Pick Stocks

Start with index funds

If you are looking to build your portfolio, consider starting with index funds.

These index funds can be either mutual funds or exchange-traded funds.

These investments are great because you can gain exposure to the market without the need to pick specific stocks.

For example, you can invest in an index fund that tracks the Standard & Poor’s 500 Index.

In short, you get the benefit of buying every stock in the index, without buying every stock in the index. Instead of buying each individual stock in the index, you can have these stocks all with one purchase.

We like index funds because they are…

  • Easy to buy
  • Come with low management fees
  • Returns are subject to less volatility

Additionally, index funds offer investors instant diversification.

Ever heard the expression “Don’t put your eggs in one basket” – this is the concept of diversification.

You can own many different assets and avoid getting burned by any one particular investment.

However, you should check out the holdings of any index fund or ETF before you purchase.

You should be familiar with the funds top holdings, if not all holdings, to some extent.

So, are you ready to buy an index fund?

There is just one thing that you need to do: open an account!

You can sign-up with an online broker or a robo-advisor.

We recommend an online broker for those that prefer to select their investments.

On the other hand, robo-advisors are great for those that seek a hands-off approach to investing.

Once you have your “base” investments in place, you can think about moving to individual stocks.

Move to individual stocks

Now that you have the foundation of your portfolio…

…we can get to the fun stuff – selecting individual stocks.

Try starting small to get your feet wet. And remember, the best experience is a hands-on experience.

With that said, it is essential to have a solid understanding of the company you are looking to invest in.

This means understanding the stock price and the general concepts of trading before you buy.

Try asking yourself these two questions:

  • Do you want to own Company XYZ?
  • Do you want the stock price of Company XYZ to go up?

If you believe in a company enough that you would like to own it – you may be on to something.

If you purchase shares because you would like the price to appreciate – you should think again.

Why is this distinction important?

Two reasons:

  • Warren Buffett said it (and you listen to Warren Buffett)
  • You are investing in a COMPANY – not a stock

If you do not like the company, why invest in the first place?

I know what you are saying…

…there are tens of thousands of stocks, how do I choose one?

Could you imagine going through every balance sheet and income statement to which companies to buy? Me either.

Luckily, this level of research is not required to be an informed investor.

You should stay up-to-date on current events, market events, and expert opinions.

The easiest way to do this is by reading blogs (like this one), magazines, and online information daily.

For example, reading an article and gaining insight into market movements can drive investment ideas.

My favorite site to get the latest investment tips, news, and analysis is the Motley Fool.

The Motley Fool can help you “beat the market” and outperform Wall Street analysts and financial professionals.

If you visit their website (www.fool.com)…

…you will discover countless free articles on critical financial topics, such as:

  • Investing advice
  • Stocks picks
  • Retirement planning

The company also boasts a robust community of members that share information and opinions about their investment decisions.

Additionally, users can access a competition-based crowdsourcing feature and other paid premium services.

And if you need some help picking stocks, be sure to check out the Motley Fool Stock Advisor.

The Motley Fool Stock Advisor

For $149 per year, the Stock Advisor comes with the following:

  • Two new stock recommendations each month
  • “Best buy” stocks
  • Foundational stocks

These recommendations are beneficial to ALL investors and provide an excellent basis for further research.

In fact, stock picks from the founders have historically beaten the market.

Tom Gardner’s picks have earned a 149% return, and David Gardner has generated a 527% return!

While there is no obligation to buy every recommendation, these guys have an excellent track record.

Stock Advisor also has a very straightforward investing model.

Each stock recommendation explains the following:

  • Current company fundamentals
  • Why the stock is a good buy for the coming years
  • Potential investment risks that might cause you to sell in the future

David and Tom have a goal for each investor to own at least 15 stocks.

Stock Advisor is also very intuitive, with each recommendation being categorized into the following categories:

“Starter Stocks”

These are foundational companies that Tom and David believe are appropriate for any new investor (these would be great additions to your index funds).

“Best Buys”

Each month Tom and David choose five stocks each that they consider “best buys.”

Stock Advisor suggests that you invest in at least three starter stock recommendations from the start.

From there, you can continue to expand your portfolio with the “Best Buy” recommendations.

In addition to following stock recommendations, you can create a personal watchlist to track specific stocks.

Given the track record of David and Tom, we consider Stock Advisor a “must have” for any investor.

Whether you are an experienced investor or just starting out…

…we highly recommend signing up for the Motley Fool Stock Advisor.

Overall, the internet is an excellent and convenient source to analyze stocks and gain insight into many different expert perspectives.

And Stock Advisor is just ONE source of information to use as a basis to move forward with your own analysis.

Thus, rather than digging through endless financial statements, you can save your time for companies that may be worth your time.

Once you have identified the stocks that you are interested in, it is time to perform your own stock analysis.

Here are some tips for when you are ready to perform your own analysis:

Price and Valuation

This section entails trying to find stocks that are “cheap.”

Cheap means that you are paying a relatively low price for each dollar the company makes.

You can determine whether a stock is cheap by looking at the company’s price-to-earnings ratio (P/E).

Here is what to look for:

  • If the P/E is below 15, the stock is generally considered to be cheap.
  • If the P/E is over 20, the stock is generally considered to be expensive.
Financial Health

Financial health is where you can start looking into the company’s financial reports.

Every public company must release quarterly and annual reports.

To find this information, you can see the Investor Relations section on the company’s website or find official reports filed with the SEC online.

But what should you look for in these reports?

Try searching for the following information:

  • Find revenue growth. The stock prices increase when the revenue increases.
  • Look at the bottom line. A company’s profit margin is the difference between revenue and expenses. Margins improve when revenue is growing, and costs are kept under control.
  • Check the debt. Take a trip over to the balance sheet. In general, the stock price of a company with more liability will be more volatile because income will be put toward interest and debt payments.
  • Know the dividend. Dividends not only provide you with income but are also a sign of financial health. Also, be sure to check and see if the dividend has increased over time.

Try options and futures

Most investors would stop by this point – but you are not “most” investors.

You have the mutual funds, ETFs, and individual stocks in your portfolio – what else do you need?

For starters, you should ensure that your diversification strategy is in-check.

For example, you may own various assets in the same industry.

If that particular industry goes down, which assets will be around to hold your portfolio up? These are the things to think about as you are diversifying your investments.

However, once your diversification is good, you should consider options.

Options are cheaper and give you flexibility with the duration of the investment and can have limited downside risks.

Additionally, if you want to speculate on the market, consider giving futures a chance.

Futures are contracts require a smaller investment and require buyers to purchase an asset at a predetermined time and price sometime in the future.

Options and futures are more advanced, so be sure to do your homework before buying.

Don’t do this when picking stocks

Now that we have covered how to pick stocks for your portfolio here are some things NOT to do when picking stocks:

DO NOT buy because the price is “low.”

You should not assume that you are getting a deal because the stock price is down 15%. Make sure that you understand the reasons behind the price drop and why you believe the stock will see better days.

DO NOT blindly follow analyst picks.

As mentioned earlier, analyst picks can be an excellent source of information. However, it is essential to be wary of ‘Buy’ and ‘Sell’ ratings can contain biases from analysts.

DO NOT sell because the price drops.

Your stocks are going to move up and down throughout the days, months, and years. Check out the 52-week highs and lows to get an idea of how widely the stock price can fluctuate.

DO NOT forget to sell.

We said do not panic – but you also need to set your limits of when to sell. Some investors sell when the company cuts its dividend, if the prices rise or fall past a certain point, or if analysts downgrade the stock. Creating a plan of when to sell will help you avoid selling too early or too late.

Summary

To recap, here is how you should build your portfolio:

  • Start with index funds
  • Add individual stocks
  • Consider options and futures

Take your time and, before you know it, you will be investing like the pros.

But no matter which investments you choose…

…it is crucial to stay on track with your goals.

Staying on track means investing regularly and tweaking your approach, as necessary.

With any new investment, be sure that you understand the company before parting with your money.

Begin by staying current on news and analyst recommendations. From there, you can conduct your own research.

After all the work you have done to narrow down your investment possibilities…

…you may be left with one company or twenty companies.

But don’t fret if your efforts come up dry – you may be avoiding one or many bad investments.

We have focused this article on buying stocks…

…but one of the most important aspects of buying is knowing when NOT to buy.

Keep savings, learning, and investing and you will be on your way to financial freedom!

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