Finding a good stock based on merits requires a fundamental analysis of the company and the industry. Stock picking also requires that you understand your risk tolerance and what your investing goals are. Once you understand your investing goals, picking a stock is easier.
How to find good stocks takes more work than just hearing a hot stock tip from a coworker. When finding the best stocks, there are two schools of thought, technical analysis using charts and chart reading techniques and fundamental analysis using metrics.
Technical analysts believe that all of the information they need is already reflected in charts. A chart of the price movements of a company’s stock can predict future price movements. They use chart patterns and moving averages to pick stocks.
Fundamental analysis is more about picking a stock based on the company’s merits, and the stock price doesn’t necessarily reflect the true value of a company’s stock. Investors that use fundamental analysis use metrics like:
- The price-to-earnings (P/E) ratio is a company’s share price divided by its annual per-share earnings.
- Price-to-earning-growth (PEG) ratios measure a company’s growth. It is found by dividing the P/E ratio by the expected annualized earnings growth rate over the next few years.
- Price-to-book (P/B) ratios, which is the net value of all of the company’s assets.
- The Debt-to-EBITDA ratio is used to determine a company’s financial health. EBITDA stands for earnings before interest, taxes, depreciation, and amortization.
Understand the Company’s Industry
To better understand how a company is doing in their sector, it helps to understand the overall industry the company is in. Research the entire industry to find out how a company compares to its competitors.
Pick several companies in the sector and compare their fundamental metrics. Evaluate how their debt-to-income ratio compares to other companies in the same sector. Using this indicator will help you determine which company is in better financial health. Making sure a company is in good financial health will let you know how well this company can handle a downturn in business.
You have to always compare companies in the same industry. If you’re interested in the home improvement industry, compare fundamental metrics with companies like Home Depot and Lowes. For example, you cannot compare a home improvement company like Home Depot with a healthcare company.
Use Stock Screeners
How to find good stocks is dependent on how well you do your homework. Stock Screeners will help you find companies that meet your investing criteria. They can also help you find companies or industries you weren’t aware of that could also be a good investment.
According to the experts at Money Morning, “Stock screeners are excellent tools to help you find good stocks to buy and can save you a lot of time. A stock screener lets you filter through hundreds of stocks based on certain parameters you set like market cap, share price, sector, price-to-earnings (P/E) ratio, and more.”
When you learn how to read the fundamentals of a company, you will be able to pick the best stocks based on their merits. Fundamentals can also help you determine if it’s time to sell an investment.