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Investing Basics

blocksThis is a simple way to start getting familiar with investing in stocks for your 401K, IRA or personal portfolio. The first step is identifying several stocks that you are interested in for your portfolio. A couple of good resources are Motley Fool Website, CNBC, Google Finance, Yahoo Finance, and newspapers like the Wall Street Journal or Business Week.

Once you have identified some stocks you are interested in, now you need to look more closely at them. The first thing you should do is write them down and leave enough room for the data that you are going to evaluate them on, Microsoft Excel also works great for this. The key things to look at are Dividends, P/E Ratios, Return on Equity, Stock Ratings, Debt, Earning, Insider Activity, and basic chart evaluations.

Dividends are payments that the company makes to the stockholder from its profits. The benefit of dividends is that regardless of what the market is doing you will get money from that stock in the form of cash payment. Dividends are paid out on a quarterly basis. When looking at dividends it is a good idea to see what the industry average is for that stock and compare. For dividend paying stocks, look for stocks with a dividend that is comparable to the industry average or above. If you would like to learn more about dividend investing, please read this article on High Dividend Investing.

P/E Ratio is the Price to Earning Ratio. It evaluates how good the stock price is and whether it is over or undervalued. For stocks with a P/E value that is higher than the average for the industry that means that investors are willing to pay more for that stock than others. Opposite holds true for low P/E values, investors are willing to pay less. There are many different philosophies on whether a company stock price is better if it is higher or lower than the average. Look at stocks that have a low P/E compared to the industry. If you buy stocks with a high P/E, you are paying a premium for investor opinion of the stock. Think of a low P/E as a stock on sale.

ROE is the Return on Equity. This is how the company uses your money that you have invested in their company through stock purchases to generate profits. In theory the higher the ROE is, the more easily the company can generate cash internally. It is a good idea to compare this number to the industry average as well. Look for companies with a higher ROE than the industry average.

Stock Ratings are a quick look at others opinions of the stock. There are many different ratings out there but the ones to look for evaluating stocks are the Motley Fool Caps Ratings and Analyst ratings. The Motley Fool website has a Caps Rating system which is a network of other investors who rate a stocks performance against the S&P based on a 5 star grading system. A five stars stock is expected to outperform the S&P, and a one star stock is expected to under perform. Look for four or five star stocks. Motley Fool also has a bunch of other information located on the stock page that is good data as well to look at but will not be addressed in this article. Analyst ratings can be found on many of the investing websites but for this article we will look at MSN Stock Scouter. The stockscouter rates stocks on a scale from 1-10, with 10 being the best, to determine the expected risk and return. Look for stocks that have at least seven in the rating systems. There is also more information available in the left navigator menu called Analyst Ratings. This tells whether according to the analysts surveyed is the stock a strong buy, buy, hold, sell, or strong sell. Obviously, you are looking for stocks that are a buy to a strong buy here.

Debt is another area that needs to be considered when evaluating a stock and given today’s credit constraints it maybe even more important. The thing you have to keep in mind with debt is that some industries carry more debt than others. It is important when looking at debt ratios that you compare them to the industry average. Look for stocks that are at or below the industry average for this part. Stay away from stocks that have debt that is higher than the industry average because the company may not be as stable as other in the industry.

Earning is one of the key things that analysts and investors look at when evaluating a company. The stock price usually follows earning. You should look at earning by comparing quarter-to-quarter and year-to-year. For example, you are looking at a retail stock that has high earning in the 4th quarter and lower earning in the first quarter. It would not be good to look at the earning and think that the stock is going down. What you should look at is the previous years 4th quarter to see if there was earning growth from that year to the current year. This is a better indicator or earning growth and a more reliable measure. Usually a company with negative earnings should be avoided.

Insider Activity is just another piece of the final decision. This information can be found on most financial websites and it tells whether the high level employees of a company are purchasing or selling their personal stock. Generally, if there is insider purchases than the employees think that the stock will go up. This is not a make or break piece of the decision just one other thing to look at.

Basic Chart Evaluations for a stock can tell you a lot about where the stock has been and where it maybe going. It is a good idea to look at a year, 5-year and 10-year chart of stock prices. Generally, you are looking for an upward trend to the stock price over the course of the company’s life. You can also look at a simple moving average of the stock price over a period. This is usually located under the technical indicators of the chart. This will tell you the trend of the stock. Set the averages at a 50-day average and a 20-day average. Where the lines cross, the stock is trending either up or down. This chart is showing that as of May 2009 this stock’s price is trending up so it would be a good time to buy.

After you have looked at all these indicators for your stocks that you have selected you can compare the results for each stock to make your decision on what to purchase. Remember you are looking for stocks with a dividend, low P/E, high ROE, good ratings, low or equal debt, positive earnings, maybe with some insider trading and a chart that shows growth in the stock price. Knowledge is power so; the more you learn the better decisions you make.


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