What Stocks to Buy: 6 Tips to Help You Make an Informed Decision

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Investing in stocks is one of the best ways to build long-term wealth. Not only can you support companies that you think are promising, but you can also take advantage of compounding and grow your money exponentially over time.

That being said, choosing what stocks to buy can be extremely confusing and challenging. Almost every public company offers stock to buy, and there are only a few stocks that are true winners in the long run.

This post will run through an overview of stock analysis and help you determine the best stocks to buy for your specific situation. Disclaimer: stock picking is tricky, and even seasoned professionals can’t successfully pick winners. This article is not (and should not be seen as) financial advice. Instead, it is for purely educational purposes, and you should always do your own research before buying making any financial decisions.

Determine Your Goals

Before picking stocks, it’s essential to determine what your financial goals are. Different stocks have varying risk levels and are better suited for different people.

A few questions to ask yourself before you pick stocks are:

  • How old are you, and how long are you willing to hold onto the stocks you buy without selling?
  • How much money are you willing to invest? Is it a large percentage of your total savings?
  • How much money are you willing to lose?
  • Can you stomach seeing your stocks lose 20% of their value in one day? What about 50% in one day?
  • Are you investing to aggressively grow your money or to just preserve your money?

Most people fall into one of three investor categories:

  1. Conservative – Your primary goal is to preserve the buying power of your money. You hope to match inflation, and maybe even beat it by a few percentage points per year. Usually, conservative investors are either retired people who can’t afford to take any risk or megarich people who want to preserve their wealth.
  2. Moderate – Moderate investors aim for returns that match the stock market and can usually take a decent amount of risk. The majority of people fall under this category and usually invest in ETFs instead of trying to individually pick out stocks (more on this down below).
  3. Aggressive – Aggressive investors aim to make tons of money off their capital but run the risk of losing all their money. These are people who usually invest for fun and are investing with money they are 100% okay with losing. Usually, these investors are young and are only investing a small percentage of their total savings.

Before trying to pick stocks, determine which one of these three categories you fall under. This will help to inform what amount of risk you can take and help you filter stocks better.

Research Various Companies

Once you have determined what your financial goals are, the next step is to research various companies that you’re interested in. The important thing to remember here is to look at the company as a whole and not just the stock graph. At the end of the day, when you buy a stock, you’re making a bet on the company, so you want to make sure the company is fundamentally strong. Below, you’ll find a few different industries to help guide your research.

For conservative investors:

  • Utilities – Sectors like water, gas, and electricity are staples and are needed by the entire industry to function.
  • Health Care – Hospitals, clinics, pharmaceutical companies, and manufacturers of medical equipment are all considered “conservative” investments.
  • Consumer Staples – Food, beverages, and household/personal items are demanded whether the economy is in a boom or a bust.

For aggressive investors:

  • Technology – One of the most volatile, but fastest-growing, industries is technology. This includes goods like computers, phones, and televisions and services like computing, logistics systems, and enterprise software.
  • Communications – The world of communications is constantly evolving and innovating. If you happen to pick the next Facebook or Google, you could make a lot of money off your investment.
  • Real Estate – As demonstrated in 2008, investing in real estate can potentially hold lots of risk. That being said, when the housing market is hot, there is potential for massive returns.

If you’re a moderate investor, you’ll want to either look at buying a mix of aggressive and conservative stocks or just buy the entire stock market via index funds or ETFs.

Determine the Fundamentals of the Company

Once you choose a company to look into, the next step is to determine the fundamentals of the company. Some questions you’ll want to answer are:

  • What does this company do? At its core, what goods and/or services does this business provide?
  • How does this company make money? Differing slightly from what a company does, you’ll want to find out exactly how the company makes money. Some companies have different revenue streams so you’ll want to figure out what their biggest ones are.
  • Who runs this company? The management team of a company often matters more than most investors expect. A hardworking and dedicated leadership team can take a fundamentally bad company and bring it to success. Likewise, the opposite can be said for a fundamentally sound company with a poor management team.

Once you have these questions answered, you’ll want to take a look at the more technical side of the company. Some things to mark down are:

  • Price-to-Earnings Ratio (PE Ratio): A price-to-earnings ratio measures how “expensive” a stock is. This measurement is taken by dividing the total “price” of the company by how much money the company makes each year. For example, if a business is worth $1 billion and they have earnings of $50 million, its price-to-earning ratio would be $1 billion / $50 million = 20. This is useful to compare the company you’re looking at with competitors in the same industry. The higher the PE ratio, the more “expensive” a stock is.
  • Price-to-Book Ratio (PB Ratio): Unlike a PE Ratio, a price-to-book ratio takes the price of the company and divides it by the total value of all the assets the company owns. In other words, if the company were to shut down tomorrow and sell all of its assets, the amount of money it would receive is its book value. A PB ratio is an important metric to help investors identify fundamentally undervalued companies to invest in.
  • Debt-to-Equity Ratio (DE Ratio): The DE Ratio of a company measures how much debt a company holds in relation to the equity value of the company. A high DE ratio can signify to investors that the company likes to take a lot of risk. That being said, certain industries, like the auto and construction industry, naturally need to take on more debt and have a higher DE ratio.

Research Long Term Trends

Once you take a look at the fundamentals of the company and have a good idea of what the business is all about, it’s time to take a look at the long-term trends of the company. This involves pulling up the stock chart of the company (which you can do on Google or Yahoo Finance) and looking at the historical performance of the stock.

  • Is the stock currently are an all time high or is it well below its peak?
  • What does the trajectory of the stock line look like? Is it a smooth line that’s easily traceable or did it experience tons of ups and downs?
  • Does the stock look cyclical at all?
  • Is the stock price rising in recent years or falling?

These are all questions that you should aim to answer before investing in anything. Generally speaking, there are a few different investing philosophies:

  • Value Investing: This is when you try to identify stocks that either extremely undervalued compared to its competitors or stocks that are currently in a lull (in a low part of the stock chart). The belief is that if you buy these stocks, they will eventually return to the mean and rise back up.
  • Momemtum Investing: Momemtum investing involves buying stocks that are currently rising (and likely at an all-time high). Momemtum investors believe that hot stocks will continue to rise and their “momentum” will carry them forward.

Look At the Dividends of the Stock

A dividend is periodical payment that a company will pay out to investors as a way to distribute their earnings. A dividend yield is the percentage that is applied to the total value of your stock to determine how much money you’ll receive in dividends.

For example, if you buy $100 worth of a stock and it has a dividend yield of 2%, assuming the stock stays the same for a year, by the end of the year you’ll receive $2 in dividends ($100 x 2%).

Though the dividends on most stocks are relatively low (and don’t usually beat out the appreciation on the stock), it’s still an important aspect of the stock to look at. That being said, some people incorrectly view a dividend as a “guaranteed” return. If the stock price plummets, the dividend payouts will also go down.

Compare the Stock With Comparable Companies

One popular way to determine whether a stock is worth buying or not is to compare it with similar companies. This is called “comparables” or “comps” in the financial industry, and the basis of a lot of professional stock analysis.

The idea is to compare the statistics of the stock you’re looking at with companies that are similar and see if you’re getting a bargain. Some ways to pick out comparable companies are:

  • Industry – The most obvious way to find comparable companies is to look at companies in the same industry as the business you’re currently analyzing.
  • Size – Big companies are usually valued differently from small companies. As such, it’s important to pick comparable companies that are similar in size for a good analysis.
  • Geography – Even if a company is in the same industry and also the same size, if it’s located halfway around the world from the company you’re analyzing, the analysis will be a little inconsistent. Good comparable companies are geographically close to the company you’re looking at.

Once you have a good list of comparable companies, you’ll want to pit your stock against them and see if your stock is “cheaper” or has better trends. One significant metric to compare is PE ratio. If your company has a lower PE ratio than its comparable companies, that signifies that it’s priced relatively cheap.

Stocks vs. ETFs

Following the above tips will give you a good understanding of the stock you’re considering and help you better determine what stocks to buy. That being said, even the best investors have a hard time beating the overall stock market.

If you’re not confident in your ability to consistently pick the best stocks, one alternative is to buy index funds or ETFs instead. An index fund / ETF is essentially a basket full of stocks and largely decreases the risk associated with investing.

The chance of one stock going bankrupt is much higher than the chance of 500 different stocks all going bankrupt at once. Studies have shown that most stock pickers can’t beat the overall stock market; ETFs are a way to buy a huge portion of the stock market and hedge against risk.

Some popular ETFs are:

  • SPDR Dow Jones Industrial Average ETF (DIA)
  • Invesco QQQ ETF Nasdaq (QQQ)
  • SPDR S&P 500 ETF (SPY)

Invest and Hold

Regardless of whether you choose to invest in aggressive stocks, conservative stocks, or decide to hold ETFs, it’s essential to keep your emotions out of the process and to hold onto your investments until you want to permanently liquidate your holdings.

One of the biggest ways that people lose money in the stock market is by needlessly entering and exiting the market. Oftentimes, people will end up selling a stock when it is low (and they panic), and then rebuying in when the stock is high (for fear of missing out).

Fidelity found in a study that the best accounts belonged to “people who had died or people who had forgotten they had accounts.” It will be better for you emotionally (and probably performance-wise) to invest and then not check your portfolio until the day you need to sell your stocks.

Recap: How to Determine What Stocks to Buy

How to determine what stocks to buy

Investing in the stock market is one of the best ways to build long-term wealth. However, picking stocks itself is difficult and not even professionals can consistently beat the stock market.

Here are some tips to help you determine what stocks to buy if you choose to embark on the stock-picking journey:

  • Determine Your Goals
  • Research Various Companies and Pick One
  • Determine the Fundamentals of the Company
  • Research Long Term Trends
  • Look at the Dividends of the Company
  • Compare the Stock with Comparable Companies

Follow these steps and you’ll give yourself a good shot of understanding the companies you want to buy stock in and making an informed decision. As always, make sure to consult with a financial advisor and do tons of research before investing any of your money.

Disclaimer: stock picking is tricky, and even seasoned professionals can’t successfully pick winners.​​In fact, that’s why many stock investors use stock market analysis tools to help them make the right financial decisions.​​​​​​​