Knowing how to evaluate and research a stock before buying it can be a massive help when it comes to investing. This may sound like a lot of work but there are some quick and easy steps you can use to carry out basic stock valuations.
Before you go and buy shares, here’s how you can try and wrap your head around an investment.
How do you evaluate a stock before buying it?
There is no definitive checklist of things you need to assess before buying a stock. But there are some factors to consider before buying shares and becoming a part-owner of a company.
Four key things you should always try to quickly evaluate before buying a stock are:
- A company’s financial records and balance sheet
- The management team and who’s in charge of the company
- What industry the company is a part of and where it operates
- Motivations of the company and what it hopes to achieve in the long run (will it be a unique market leader or a solid moneymaker?)
Understanding these will give you a decent overview of the stock. Some areas will be subjective and it’s not an exact science. But before you invest, you should think about what the company does, who runs it and how it makes its money.
How do you evaluate the value of a stock?
Once you have a decent grasp of the company you’re thinking of investing in, it’s a good idea to do some basic stock valuation and look under the hood. Don’t worry, some of this you can easily find online or through your share dealing account.
Price-to-earnings (P/E) ratio
This is a really basic tool of stock analysis. Knowing this figure will tell you the value of a company’s share price relative to how much money it is actually making. So you’ll get an idea about whether a stock is overvalued or undervalued. A high P/E ratio means that a company is trading for much more than it is generating in earnings.
Does the company you’re looking at pay dividends? If so, you need to think about how this affects your portfolio and your tax position. When a business pays dividends, sometimes this can mean less growth.
But on the flip side, a steady dividend-paying stock may be more stable. Understanding how the business tries to reward investors (through income or growth) will let you know if the company fits in with your investing strategy and goals.
Stock charts and volatility
Past performance doesn’t dictate future results. But by looking at the stock charts and share price, you can easily see a couple of things.
Is the price generally heading in an upwards or downwards direction? Is the movement steady or are there big ups and downs in the charts? This is a simple way to evaluate the price of a stock before buying. It will give you an idea about how volatile the shares are.
How do you know what a good stock is?
There’s no list of good stocks and bad stocks out there. Sometimes, a stock with great fundamentals and a top team may perform poorly.
It’s important to understand that even evaluating a stock before buying it doesn’t guarantee that you will only pick winning investments. However, by following some of the steps outlined above, you will be in a better place to make an educated investment.
Different people like to research stock in different ways and there are lots of methods out there. Learning some of the basics of stock valuation will help improve your investing decisions. But if you’d rather leave all this to the professionals, it might be worth considering an investing solutions platform to help manage your investments.
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