Stock Basics 101 - Evaluating Stocks

Investing Over Gambling

Anyone can buy stock, it's not hard if you open and fund a brokerage account.  You can then go out and select from tons of stocks, and you can say I'm going to put this money all in Apple, or in Google and Facebook without any analysis.  You may or may not do well with this strategy as it will somewhat largely hinge on your psychology in dealing with a constant in the stock market and that is stock price fluctuations.  The thing of concern to most investors is that the price goes up from when they got in.  However, we really have no control of what is going to happen once we are in it, but if we have done some research, and have a sufficient and realistic time horizon, and have a basis for why we are buying particular stock(s), we can have more confidence that we are investing instead of just gambling.

Owning Companies That Share Profits

One of the main reasons for investing in stocks, I have established in my blog post, "Blacks Don't Invest In Stocks and Bonds" is about having an ownership in companies that are producing products and/or providing services and are, we hope if we own them, generating increased revenues and bottom line growth and profit, which can often lead to an appreciation in value of our investment/money over time.   So, how can we evaluate stocks?

The Novice Perspective

Let's take the perspective of a novice investor ready to invest their money, but not wanting to lose his/her money, and trying to navigate how to go about this.  Before thinking about gain or loss, think whether you want to be an owner of the company in question.  For example, personally, I don't want to be an owner in oil company stocks when I'm actively investing; though through passive S&P 500 index fund I'm still exposed only because they are part of the index's basket of stocks, but I'm OK with that as well.  So, with individual stocks, you can chose those you want to be involved in and exclude those you don't want.

Evaluate Companies Who's Products/Services You Use

The medium by which you will search out stocks to chose from is all on you as there is online, via financial newspaper, brokerage platform, etc., but it's not a bad idea to evaluate the stocks of companies who's products and services you are a consumer of already as you and other customers are contributing to that companies revenues.  I have done such a thing on Motif Investing with Os Own What You Love where I created and then bought the motif of stocks who's products and services I largely utilize with some, but not a lot of, analysis because I will dollar cost average (consistently buying into positions when the price may be higher or lower than original prices I initially bought at) into these positions over time and these companies are largely ubiquitous and have long term prospects.  Once you are comfortable, then expand horizon to other stocks outside your initial realm.

I have also broke down some of the stocks in this portfolio in the below blog post:

 Loyal3 10 Stock Plan (Loyal3 is Now FolioFirst)

Loyal3 10 Stock Plan Addendum

My Basic Evaluation Approach

My approach to evaluating a stock is more of an introduction and is by no means definitive.  This is not an exact science and you may grow to have your own way to evaluate if and how to select stock(s) you want to buy.  Based upon my knowledge and experience, I just lay out a few things that stand out in my mind that I look for when I am evaluating an individual stock.  If just starting out too, it may be wise also to have more of a tilt towards being a value oriented investor, as their philosophy is towards buying stocks selling at a discount to others and have a margin of safety inherit in that you are buying dollars for less than $1.

I personally look at few metrics I learned as value investor which are:

• P/E ratio (less than 19)
• Dividend Yield (greater 2%)
• 52 week high/low (towards low end)
• The chart (10 year chart sloping generally upwards)
• Return on equity (15% or greater)
• Revenue growth (growing or even)
• Net margin (15% or better)
• Debt to equity (less than 1 or dependent on others in same sector)
• Current ratio (above 1)
• Quick ratio (above 1)
• Moat like qualities (best in brand)

Note:  Metrics have links to Investopedia which often are accompanied by video to explain these concepts.  

The Research Gets You Through The Downturns

These are the metrics I generally use to evaluate if I'm getting a solid company without just guessing, because we can guess for sure, but that is too much like gambling!  We are investors and don't gamble, right?!  The evaluation is mainly for you to be able to stick with a company when there are price downturns.  If you know nothing about the company how do you know if this is just short term or not.  This evaluation by no means that a stock's price will not go down less than what you bought it at and if it does go down that you picked a bad stock.  Sometimes it just a wait and see and the wait is better when a company pays a dividend while you do so.  

Using Apple as an example, it's 52 week low was $92.14 and now it's $145.82.  There were plenty of naysayers to this stock of why it wasn't great, but it sported a P/E of 11 at one point with a 2% dividend selling at tremendously cheap price compared to other stocks, yet it stands as the largest market cap in the world, with $200 billion in cash overseas and tremendous balance sheet.  This for me was a no brainer as I got in at $92 price range and even a little at $100 plus.  I have done well.  This was a time to get in and select an individual stock(s) to outperform and it has. 

Pick Your Spots

This blog post discusses evaluating single stock, but in future blog post I'll discuss index and ETF investments which are more of a basket of stocks weighted to some benchmark like the S&P 500.  In investing in individual stocks, your aim should still be performance that beats a benchmark like the S&P 500.  There are certainly times that arise, like the example above with Apple stock, when selecting individual stocks are appropriate when you feel you can outperform the benchmark because of the price you buy stock(s) at or you may just want to be overweight in particular stock names.  There are always times to be investing in an index fund as this, in my opinion, should be the core of your holdings, but at lower prices is always optimal. 

In Closing

As when you are buying anything, you are I hope trying to get it at the cheapest price though your value of it may be greater.  Investing in stocks doesn't have to be hard at all if you are comfortable evaluating stocks.  This often seems to be a daunting task that those on Wall Street seem to think Main Street cannot master; however, in my opinion, that is not the case.  If you look at it, professional money managers are losing money all the time in the stock market and they are supposed to be the experts.  They often don't beat their benchmarks after fees and costs, so how much better are they?  Is this something you could do yourself?  I would say you can if you educate yourself in the what, why, where, and how's of investing.

Look Out For and Vote On Poll

I'll post a poll where I would like you to submit stocks you have evaluated and think can be winners.  I will then post the results. 

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Also, next time you think to shop at Walmart online, how about clicking through on the banner ad at the bottom of my blog site.  It will be appreciated, but also check out my blog post Loyal3 10 Stock Plan.  If you are spending money in Walmart, you should be owning it too!