Investing Basics: How to Pick a Stock

The best investment plan is one that is diversified and supports your personal financial goals. What is a diversified portfolio anyway? That just means that you have investments across different types of assets (bonds, shorter-term investments, cash, and fixed assets like your home are just a few types.) Essentially, investing across all different types of assets helps to spread out your investment risk over time and industries. This gives you a better chance to see meaningful returns over the long run. Once you’ve got some basic investment skills and retirement planning underway, think about adding a couple of individual stocks to your portfolio.

 

Consider Your Budget And Goals

First thing’s first — stock buying should not be your primary investment plan. It would be too risky to build an entire portfolio out of company stocks. It can, however, be a fun way to make a portion of your investments feel more personalized by buying into a company you’re excited about.

A good rule of thumb is that individual stocks should be about 10 percent of your investment portfolio or less.  That’s because of the high risk concentration of  owning companies compared to other ways to earn returns. When you’re buying shares of corporate stocks, you are a part owner of that company and your investment’s value can change quickly depending on the company’s performance.

 

Buy What You Know

One of the best ways to get in the stock game is to start researching a company whose products and services you are familiar with.  Whether it is a restaurant chain you love, a tech company whose products you can’t stop raving about, or one of your favorite brands — this is a good place to start. A beloved company certainly isn’t the only thing you need to think about here, but provides a good backdrop to understanding the business.

Overall, you want to think about companies that you believe have a strong competitive advantage over time. Think about the qualitative factors you’d care about as an employee of the company — do you think they have strong leadership? What are you reading about them in the news? What new international markets are they exploring and what are the conditions like in those countries?

A broker can provide you some of this, but part of the fun of individual stock picking is doing your own research.

 

Research Like a Banker

Once you have a few companies or an industry in mind, start researching like a banker! It can seem intimidating to navigate through all of the jargon on financial statements, but there are a number of ways to educate yourself. Then start by looking at a few key things:

  • Price Earnings Ratio: The P/E Ratio is a way to see how much investors are paying for each dollar the company earns. It is simply calculated by the price per share divided by earnings per share. (Hint: You can also just search for it on investment websites.) The lower this ratio, the “cheaper” a stock is, and shows its value relative to its profits. Generally, a ratio under 15 is considered “cheap” and potentially a good value, but this isn’t the company’s whole story.
  • Revenue Growth: This is the company’s total sales. Simply put, you want to see that the company has the potential to keep making more money and that its sales are growing. Profits are important too, but can be a little more complicated when you take into account tax changes or expense cutting that can sometimes hurt long-term growth prospects. Are both profits and revenues trending upward? You’re on the right track.
  • Debt: Take a look at the company’s liabilities. Just like we’d assess on our own balance sheets, do they seem over-extended? Again, research where their debt is trending as well as how that compares with their competitors and the industry overall.

 

I Have Some Picks! Now What?

Once you’ve got an idea of the stocks you are interested in, you’ll need some actual investment tools. You’ll almost always be going through a broker. Brokers charge commissions for executing trades, so be sure you’re very familiar with their pricing structure.

Discount brokers include places you’ve heard of, like Charles Schwab, TD Ameritrade, and E*Trade.  Full service firms (Morgan Stanley, UBS, Edward Jones, etc.) are good places to go if you have little to no experience in investments and want to be sure you’re getting detailed guidance.  You’ll pay a higher commission for these, but can ask a lot of questions and be walked through company recommendations.

Apps offered by tech-forward firms like E*Trade are a great place to begin. Almost all will offer you you the ability to get real time quotes and place trades right from your phone as well as some general investment advice. Newer trading platforms like Robinhood are also a great option if you’re looking for a low-fee no frills way to start investing directly in stocks!

 

Know When to Get Out

Just like all investing, stock purchases are risky. Stay informed! You’ll want to keep an eye on your target industries and company to know when it’s the right time for you to potentially get out of the company and sell your shares.

There’s no guarantee that you will get back the money you invest or put into a brokerage account. Being early on in our careers, however, means we have longer for those sharp market movements to average out over time and hope for healthy returns in a diversified portfolio.

 

Not Quite Ready For Individual Stocks?

If you’re new to stock picking,  a fund does some of the heavy lifting, diversifying your investment base and spreading out your risk among various companies.  Equity funds or exchange traded funds allow you to buy into tiny pieces of many different stocks in one “transaction.” Putting a few different funds together can be a great way to diversify your investments and still go beyond the passive investing most of us do in our 401k.

If you have a retirement plan with your company, you might already have a portion in stocks.  (You generally can’t pick a single stock, but can sometimes focus on a particular industry or market size.)  One way to stretch your corporate stock exposure is to check in on this and adjust the percentage of your portfolio that goes to companies’ investment.

 

Have you ever picked an individual stock? What research did you do beforehand?

  • Taste of France

    What is the source of your claim that 10% of your portfolio should be in individual stocks?
    For better advice, listen to the Freakonomics podcast. Last week’s episode is titled “The Stupidest Thing You Can Do With Your Money.” If active mutual fund managers can’t beat the market consistently, and they have armies of people to research the companies, what makes you think you will do better? Individual stocks come with high risk and high fees.

  • Daria Ed

    I love your blog ! Amazing job.
    Keep it up x

    -Daria

    https://www.bloglovin.com/blogs/daria-edu-19010657

    http://dariaed.com/

  • WarnerFamily

    This is an incredibly misleading and innacurate post about an important topic. In fact, there is a lot of research showing that you shouldn’t buy individual stocks and are much, MUCH better off buying ETFs and holding them for the long term.

    If you want to buy just one thing, buy the ETF VTI, Vanguard total index ETF, that way you’ll own a slice of the ENTIRE market, not just one company. This is a much better approach, and far less risky.

    All of the significant research on investing over the past quarter century, including modern portfolio theory, advocates for ETFs over individual stocks. Ask Warren Buffet, this is the approach he advocates for his own children.

    You can start investing in ETFs through Wealthfront, Betterment, Ellevest…there are tons of low cost options.

    I have enjoyed reading this blog in the past, but am frankly appalled by this article, which should never have been written in 2017 given that all of the most up to date research on this topic is AGAINST the approach you’re advocating here. It’s shameful that you’d consider publishing this, and very misleading to your readers.

    If you want a quick primer on personal finance read the personal finance section of the NY Times.

    • Maria

      Thanks for commenting on this post. I am among those of us who don’t know much about the topic, I was actually going to google and start researching this method of individual stock picking. Thanks for the advice. I will check NYT. Any other suggestions on learning how to invest?

      • WarnerFamily

        Hi Maria,

        Here are some resources that I think are a great starting point:

        The Index Card book by Harold Pollack and Helaine Olen

        For a shorter version you can read the Washington Post article that inspired their book:

        https://www.washingtonpost.com/news/wonk/wp/2013/09/16/this-4×6-index-card-has-all-the-financial-advice-youll-ever-need/?utm_term=.17637d7a813b)

        (And you might note that on that small index card they include the phrase “never buy or sell an individual security [i.e. a stock]”
        —————–

        I think their advice is spot on.

        1) Max out your employer match if you have one (I don’t, my husband does). This is basically free money. How often do you get free money? Not that often…

        2) Be very very wary of fees. You shouldn’t be paying your bank a lot of fees, ideally you aren’t paying credit card fees because you pay your bill in full every month. You shouldn’t pay to get your credit report (free at creditkarma.com).

        2b) Betterment, Vanguard and Wealthfront have low fees, and are great places to open up a ROTH IRA if you don’t have one already. This is a type of retirement account where you pay taxes now, but not when you withdraw in retirement. The max yearly contribution is $5500. They don’t pick stocks, they buy broad, diversified index funds with low fees.

        3) If you can, automatically have part of your paycheck go directly to a savings account (and pick a savings account with no fees and the best rate you can find, I use Barclays). People who do this are much more likely to save.

        These are the basics, but if you can manage this you’ll be ahead of the pack.

      • Emily

        Paula Pant’s Afford Anything blog has some great primers on getting started with investing (she’s real estate focused, but covers everything) – I agree with her focus on index funds.

    • Sharifah

      You just taught me something!!

      Thanks!

  • Ming Hui Tseng

    Totally agree with the people who are saying encouraging individual stock picking is not a good idea and definitely not for Everygirl.

  • Emily

    NOOO don’t buy individual stocks…especially if this is the beginning of your portfolio. Index funds are a MUCH safer bet. VTSAX is a good start, and Vanguard is an awesome place to hold them.

    • Emily

      Also – Acorns is an awesome way to invest a little at a time. It rounds up your purchases to the nearest dollar and invests the difference (and picks the funds for you)…
      acorns.com/invite/A5RTM6 …in 1 month I have > $100 and didn’t even notice the difference in my bank account.