One of the most challenging things you as an investor in the stock market need to figure out is, whether a stock is a good buy or not. There are so many places to get investment info these days that it becomes difficult to know which advice is right.
Even if you try to decide on your own, how do you know what you should be looking for? And if you happen to find those answers, how do you know that you’re not forgetting some important piece of information that will make or break your stock pick?
That’s a Good Stock
Many people’s understanding of what makes a good stock to invest in, is affected by how we look at things in our everyday lives. They’re so subtle and we’re so used to them, that it’s hard to see the effects that they truly have on us.
Take a green light for example. If you’re on a road or street and you see a green traffic light, you expect all of the vehicles to be moving. Green means go. Have you ever been sitting behind someone who didn’t see the light turn green and they’re just sitting there? What happens? Everyone behind them blows their horn…or worse, to let them know that they should be going forward.
On the other hand, look at the color red. When you see a red light on the street, what are you expected to do? Nobody moves. Red means stop. Stop signs are red, ‘Do Not Enter’ signs are red and the list goes on. Pretty much everything meant to be a warning or that could be bad for you, uses the color red.
Amy Morin at Forbes.com examines how the color red can reduce analytical thinking. She goes on to say that some people have a built-in negative reaction to red.
The next time you get a chance, take a look at the direction the stock market went on a particular day. On many evening news shows, there’s often a recap of the market direction for the day.
You’ll hear things like ‘the market was down 50 today‘ or ‘the index closed 60 points higher.’ Usually, they’ll use a graph to go along with the story. If the market went higher, you’ll see the numbers written in green. There might even be a green arrow next to the numbers.
Of course on days when the market went down, the numbers are always in red. And yep you guessed it, there’s usually a red arrow right next to the numbers and graph. Most things dealing with money and finance are usually shown in green and red. It’s how you can tell at a glance if the numbers are positive or negative.
Needless to say, when we see a stock with green or red numbers associated with it, we tend to think the stock is good or bad just on that information alone. For a long time, I used to think that way.
If a stock was going down in price it had to mean that it was a terrible company to own. And if I saw the numbers in green, I would almost guarantee you that the stock was a buy. Not anymore.
What’s Your (Exit) Strategy?
A more complete way of looking at whether or not you should buy or sell a particular stock would depend on what investing strategy you want to use. Do you simply want to buy and keep the stock in hopes that it goes up in price?
Or are you looking to own shares to receive dividend payments every year? Of course, there are a few basic things you can look at to tell if a stock is fundamentally a good company, but I’ll get to those in a minute.
Look at owning stock shares like owning a tool. You need the right tool for the right job. Is a hammer better than a pair of scissors? Depends on what you need to do. If you need to put a nail on the wall to hang a picture, then a pair of scissors probably wouldn’t be too helpful. A hammer, however, would do the job perfectly.
There will be many stocks that you will not want to own. Oftentimes, situations come up where owning those very stocks could put money in your pocket. In order to take advantage of those kinds of events, you have to keep a close ear to the news in different industries.
You won’t always be able to take advantage of every opportunity to own stock that’s about to make a huge move. Don’t worry. There’s always another stock that you can profit from.
So What Criteria Do I Use?
Many people are looking for stocks to buy and hold on to, so let’s look at what makes a stock a ‘buy’. One of the best resources I have found online is Zacks.com. Here you can find a ton of fundamental information about a stock, from quarterly earnings reports to how much debt a company has.
Many stock websites that report these same pieces of information, get their numbers directly from Zacks.
There are far too many numbers to analyze on Zacks in one sitting, so I’ll give you a few things to look at that can hopefully tell you if this is a stock you’d like to buy.
1. P/E ratio.
The Profit to Earnings ratio or P/E ratio is a very common number people use to tell whether a stock is a good value or not. What this number tells you in a nutshell, is how much money you would be paying for every $1 in company earnings.
A stock with a P/E ratio of 15 lets you know that investors are willing to pay $15 for every dollar in company earnings. The higher the number is, the more it implies that people are expecting the stock to eventually have a lot of growth. Many internet and technology stocks tend to have a higher P/E as investors are looking for higher returns down the line.
Of course, P/E ratios do and will change. It’s a good practice to keep an eye on the ratio, especially after earnings reports, to see if the stock is still something you’d like in your portfolio. You’ll notice stocks that have similar prices can have very different P/E ratios. The question you have to ask yourself is how much are you willing to pay for their earnings.
2. Stock Price
Yep, the price of the stock. I know it seems pretty obvious but the stock price can tell you a lot about whether a company is a good buy or not. What you actually want to look at is the price history of the stock.
There isn’t a stock that goes up and never comes down. But there are quite a few stocks that if you look at them over the long run, have pretty much slowly risen in value.
If you’d like to get more details on what exactly you should look for on a stock chart, check this out here.
News is one of those things that you can’t easily measure how much it will affect a stock until it’s already happened. Sometimes that absence of news or even just a rumor can cause a stock to move in the opposite direction you were expecting.
For any stock that you currently own or are thinking about buying you should always regularly check the news about it. Nearly every website that has stock quote info has related news available for stocks.
You want to be very familiar with what is going on within the company. Is the CEO or any other officers thinking about leaving the company? Are they investing in research for a new product or service? Is there an earnings report coming up?
When I first started learning about stock investing, I can’t tell you how many times I neglected to check the news about a stock I was about to buy. I’ve bought shares before an earnings announcement not knowing it was about to happen the next day. I even traded shares for a company that was undergoing a lawsuit.
When you’re looking at the news for any company you want to make sure there are no surprises coming up. If you check the news and you don’t see any red flags, you are good to go. Even a fundamentally sound company that has negative news going around about it is oftentimes a stock that you don’t want to own, at least for now.
Remember the BP Gulf oil spill? All during the clean-up, their stock price continued to go down. Only after the spill was being cleaned up and the bad publicity started to go away did their stock begin to turn around.
In conclusion, a good stock and a bad stock really depend on how you are looking to make money with it. Try to look at all stocks as a tool. And then try to find the best tool for the job.
Make sure you always pick the best stocks.
Download my free cheat sheet and never get stuck with a bad stock again.