How to pick stocks: 7 things you should know

These tips can help investors decide whether to buy shares.

  • By Miranda Marquit,
  • U.S. News & World Report
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Not all investors are big into stock picking. Many portfolios include a few stocks that the investor thinks have potential (and that pay dividends). When you decide to try your hand at stock picking, it’s important to do your homework. You want a good value – especially if you plan to hold on to something for a while. Here are seven things you should know about a company before investing your hard-earned cash.

Earnings growth

Protecting your portfolio

For investors seeking shelter against market downturns, here are seven options to consider.

Look for trends in a company’s earnings growth. Over time, do the earnings generally increase? If so, it’s a pretty good indication that the company is doing something right. You don’t need to see a dramatic increase for a company to be a good choice, though. Even small, regular improvement over a long period of time can be a positive indicator.

Stability

The nature of the stock market – at least day-to-day and year-to-year – is volatility. At some point, a company is going to lose value in the markets. But what really matters is long-term stability. In general, trend lines smooth out and head higher. Look for that with individual companies as well. A company that weathers the downturns and comes back relatively strong, and that only seems to have real trouble when everyone else does, is probably a good bet.

Relative strength in industry

Start by looking at an industry represented in the market. Does it have future potential? Industry can be a great screener when investing. However, when picking individual stocks in an industry, such as energy, you need to look at where the company fits in. Is it well-placed against competitors? Is there an advantage that allows it to stand out? If so, you might have found a winner.

Debt-equity ratio

All companies carry debt – even Amazon.com (AMZN) and Apple (AAPL). But that doesn’t mean you can’t use that debt as an indicator when investing. Watch out for companies with high debt levels relative to their equity. To find this number, divide the total liabilities on the company balance sheet by the total amount of shareholder equity. For those with a lower risk tolerance, that number should be at 0.3 or less. There are exceptions. For example, look at the debt-equity ratio across an industry. In the construction industry, with its reliance on debt funding, a higher ratio might be acceptable. Just make sure your pick is in line with industry norms.

Price-earnings ratio

You’ve probably seen this around. The P/E ratio offers a measure of how well a stock’s price is doing relative to the company’s earnings. When using fundamental analysis and value investing strategies, P/E ratio is considered a major indicator. To find the P/E ratio, divide the current share price by its earnings per share. If a company is trading at $40 per share, and the earnings per share are $2.50, the P/E ratio is 16. The higher the P/E ratio, the more likely it is that there will be significant growth in the future. P/E ratio isn’t everything when investing, but it can be helpful to compare companies in the same industry or sector.

Management

How much do you trust the people at the top of a company? Does their leadership promote a stable and long-lasting company culture? Is the company innovative? Adaptive? How are they investing back into the company and in the community? A well-managed company is often one that enjoys stock prices that trend higher. Take into account scandal as well. A company with staying power can weather short-term scandals – especially if a leadership change prompts forward momentum. It’s hard to gauge the outcome of a scandal, but buying during a dip can garner you a good deal and position your investing portfolio for future success.

Dividends

Many investors like to look at dividends when picking individual stocks. A company that pays dividends is often one with a degree of stability – especially if it’s a dividend aristocrat that’s increased its payout consistently each year for decades. Watch out for companies that have very high yields, though. A spike in dividend yield can mean a company is getting desperate. High dividends can also sometimes be an indication that a company isn’t investing enough in itself. Look for companies that pay modest, but regular (and increasing) dividends over time.

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