Stocks: Buying, Selling & Researching

 

Basics

When you own a stock, you actually own a piece of a company Stock Types Common & Preferred.  How much of the company you own depends on how many shares you own, and the total number of shares outstanding.  When a company decides to raise funds from the public by issuing shares, the first offering is called Initial Public Offering (IPO) . When you purchase a stock or sell it, it is called Trading Stocks & Types Of Orders

Before you buy a stock you need to research the company.  Most of this information is available for free.  However, for a fee, there are services (Financial Planners & Other Places For Financial Advice and brokerage houses Stock Brokers & Brokerage Accounts that can provide you the tools you need to make your decision using extensive databases or comprehensive reports about companies with their recommendations.  There is no one secret key that unlocks financial success.  You have to not only research the company you are considering buying in to, but also its competitors and the industry to be able to see if it is going to be successful in the world it operates in. Stocks: Buying, Selling & Researching .

You really should understand the companies you invest in.  For example you should know what the company does or makes.  You should be able to explain how the products or services are used, and who the buyers are.  You should be able to explain what their competitive advantages are.  Make sure to keep a watchful eye for not only news about the company but also its industry and competitors.  Finally, keep tabs on what other people are saying about the company.  Remember it is your hard earned dollars that you are investing.

There are thousands of analysts who follow the performance of publicly traded companies.  Most analysts work for brokerage firms but there are also analysts that work for independent research firms.  An analyst specializes in a specific industry such as retail or technology.  They issue reports with their findings based on the existing fiscal health and projected performance of the company.  The research is the background for their conclusion which is a recommendation to buy, sell or hold a company's stock. If in between formal reports an analyst feels that the company's fiscal condition has changed, they might either upgrade or downgrade their previous ratings.  Some analysts have a better reputation than others, and various services rate their performance, such as the Wall Street Journal
http://online.wsj.com/public/page/best-on-the-street.html.  But the news services generally report on analysts findings especially when they change a recommendation.  These reports and coverage of the report can have a significant impact on a stock’s price.  A buy recommendation can cause the stock price to increase, while a sell recommendation generally forces prices down.  It is important to be aware of what these analysts are saying about a company whose shares you own or are considering owning.

There is no one single proven method for investing success.  Successful investors often adopt different investing strategies.  You have to decide which is best for you given your tolerance for risk, age and time frame for investing.  Remember markets go in both directions, up and down.  Anytime you invest you are taking a risk.  In most cases the higher the risk, the greater the reward.

One method many investors have found success in is identifying and investing in companies that offer both strong growth and high value and then holding on to the stock for the long term, which can vary from three to ten years, assuming the companies’ fundamentals and performance remains the same.

Most financial advisors also recommend that you have a diversified portfolio which produces better-than-average total return on your investment.

Once you decide to invest in a stock, you need to examine not only how Trading Stocks & Types Of Orders  but where Stock Brokers & Brokerage Accounts to place your trade.  Since timing the market is important, but is impossible to predict, some people use what is called Dollar-Cost Averaging when purchasing stocks (see below).  Dollar-Cost Averaging is an investing strategy, for long term investors, which spreads your purchase of a stock over time thus reducing your cost per share.  Finally, you also have to keep an eye on the company to look for signs that it is time to sell, even if the stock at the moment is profitable.

 

 

Buying Stocks - Information Is The Key

Research is the key to finding a good company to buy in to.  You need accurate information and then know how to interpret it.  You not only have to find out information about the company, but also its competitors, and the industry it is a part of.  You have to investigate the companies, their historical performance and current performance and try to look for clues for its future performance.  As we have stated before, companies operate in the world around them, so you have to look at the larger picture too.  First you have to look for information on a company.  The best place to start is the company itself.


 

Corporate Reports, Financial Statements & Balance Sheets

When a company goes "public" Initial Public Offering (IPO) and sells shares to the public, in order to protect investors from the government, the SEC Stock Market & Security Exchanges requires these companies to provide certain information so that investors have an accurate picture of the company in order to assess the company’s performance and future prospects.

One source of information about a company is from their own financial reports and press releases.  The best places to obtain these are either directly from the company itself (or company's website) or from the Securities and Exchange Commission (SEC) Website:
http://www.sec.gov/edgar.shtml.

The SEC
http://www.sec.gov, the governing body for stocks in the United States, requires all publicly traded companies to file numerous reports (with special number/alpha codes) to keep investors up-to-date on what is happening with the company.  These reports can be obtained from either the company’s Website or http://www.sec.gov/edgar.shtml.  The major ones are:
  • Annual Report to Shareholders (10K)
    • Provides a financial statement and balance sheet for the previous year. Management will highlight their successes and some things that may not have worked out as planned.  They will also discuss changes that they might make to improve their performance. Footnotes often hold interesting pieces of information.
  • Quarterly Report to Shareholders(10Q)
    • Shorter than the annual report, but contains much of the same information. It is also called the earnings report.  This keeps you abreast of the latest changes and the company’s financial performance.
  • Current Reports (8K)
    • These are released if a company has a major announcement they think shareholders need to know about.  This could be a bankruptcy, merger, acquisition, change in top management, etc.
  • Insider Trading (Form 4) & Major Shareholders Trading & Acquisition (13D and 13G)
    • If a member of the company’s top management or Board of Directors decides to sell or purchase shares or cash in options, they must report it to the SEC.  The SEC then reports it to the public.  Options are an incentive some company's offer their top management as part of their employment package.  Options give the person the right to purchase shares at a certain price.  The price is generally at or below the market price at the time the option is granted and is offered at that price for a specific period of time/years.  Many people look at those inside the company/major shareholders purchasing or selling behavior as clues to how management and major shareholders view the future of the company.  If they are purchasing shares, many believe it is a positive sign that the future looks good.  On the other hand, if there is a great deal of selling, find out why.


 

Interpreting Financial Statements & Balance Sheets (Fundamental Analysis)

Financial statements and balance sheets are complex.  The best way to learn is to take a course in accounting or read a book about accounting or financial statements.  A successful active investor will need to be able to read and interpret corporate financial data.  Different investors will focus on different factors.  However, even the novice investor can look for certain key pieces of information and learn a few key ratios that can help them with their investing decisions.  Here are just a few things you might look at.  There are many more for the more seasoned investor.


  • Earnings:  If a company isn’t making money, chances are you won't either.  Earnings are probably the single most important figure to look at.  Earnings are what a company makes after it takes out its expenses.  Earnings are the most important ingredient in calculating the value and performance of a company, especially how it stacks up against its competitors, industry and the market.

 

Things To Look For:

  • Look for companies with a consistent growth in earnings. 
  • Look for companies whose annual earnings in the last three years have significantly outpaced the market. 
  • A company whose earnings are growing faster than its competitors should also have a stock whose price should grow faster too.
  • Well managed companies generally take a significant share of their earnings and reinvest them back into their business to fuel the company’s growth.
  •  Earnings Per Share (EPS):  This is an important figure to find out, and it is the basis of many other calculations.  It starts with the profits a company earns after taxes, bond interest, and preferred-stocks payments have been made.  This figure is then divided by the amount of common shares outstanding. 

    Example:  A company earns $10 million.  If it has 5 million shares outstanding then the EPS is $2.

 $10mil (earnings) 5 mil (shares outstanding) = $2 EPS

 

Things to look for:

  • How does the current EPS compare to the stocks historical performance?
  • How does it compare to professional analyst expectations?
  • Look for a company whose earnings "beat" analyst expectations.
  • Are the profits from routine operations or are they from a one-time occurrence, such as sales of a division or assets?  You should look for profits from routine operations.
  • Look for a company whose EPS in the latest quarter is higher, preferably much higher than the same quarter a year ago. 
  •  Price-Earnings Ratio (P/E) (aka: Multiple):  Many investors consider the P/E ratio to be the single most important measure of a company.  It shows you how much an investor is willing to pay for each dollar a company earns.  Companies with no earnings or losses do not have a P/E ratio.  The most frequently quoted P/E is a "trailing" P/E ratio, which is based on the previous 12 months.  Some analysts also forecast next year's estimated P/E ratio which is called a "forward" P/E ratio.  The Price-Earnings Ratio (P/E) is the price of a share divided by the Earnings Per Share (EPS) (see above).

For example:  If a stock is selling at $20 and has an EPS (Earnings Per Share) of $2 in the previous 12 months, it has a "trailing" (looking back) P/E ratio of 10.

 $20 (price per share) ÷ $2 (Earnings Per Share) = 10 P/E It is so important you generally can find a stock’s P/E ratio in newspapers and financial websites often next to the stock’s price.

 

 Things to look for:

  • How does the company's current P/E ratio compare to:  Its historical P/E the P/E of other companies in the same industry; how does it compare to the market in general such as the Dow Jones or S&P 500.
  • Investors usually are willing to pay more to own shares of a company whose earnings will out-pace its competition.
  • Some people look for companies with low P/E ratio if they expect a company to prosper in the future, or if its industry is projected to experience growth.  But make sure that you have good reason to expect the company to grow in the future.  A low P/E ratio could just be a sign of a poorly performing company.
  • Also look at "forward" P/Es based on analyst expectations, "Trailing P/E" only tell you what happened.

Example: If a stock is selling for $40 and pays $2 a year in profits its dividend yield is 5%.

 


Things to look for:

  •  Compare the dividend yield of a company to its competitors.  Dividend comparison varies by industry.
  • Has the company historically raised its dividends?
  • Look for companies with rising dividends and rising earnings.
  • If a company cuts its dividends this usually signals a problem.
  •  Return on Equity (ROE):  Explains how efficiently the company uses its money. Technically, it is the company’s net profit after taxes, divided by its book value.


Things to look for:
 

  • Return on equity that grows year after year.
  • Look for a company with a Return On Equity of 15% or higher.  The higher the better.
  • If the ROE is up and down, or just plain down, the company might have a problem with debt or profit margins.

 

 

Purchasing Stocks Through Dollar-Cost Average

Everyone always wants to buy stocks, or any securities such as Mutual Funds; or Bonds, at their lowest point and sell at its highest point.  Guess What?  It is impossible on a consistent basis! In our section Trading Stocks & Types Of Orders we discussed the general principals of how to buy and sell stocks.  One way to avoid timing issues and being able to buy more shares when prices are low is called Dollar-Cost Average.  This is a proven strategy for long term investors.
  • Dollar-Cost Average:  With dollar cost averaging you invest a fixed amount at fixed intervals of time into the same security.  You end up paying an average price that is lower than the average price of the security, since you are purchasing more shares when the price is less.


Example:  Every month you decide to invest $100 in High Five Company.

1st month: The stock is $10.00 your $100 buys you 10 shares
2nd month: The stock is $12.50 your $100 buys you 8 shares
3nd month: The Stock is $ 5.00 your $100 buys you 20 shares
4nd month: The Stock is $10.00 your $100 buys you 10 shares
5nd month: The Stock is $20.00 your $100 buys you 5 shares
6nd month: The Stock is $10.00 your $100 buys you 10 shares
Total 6 Months You Invested $600 63 shares




Your Average Purchase Price ($600 ÷ 63) = $ 9.54
The Average Price of the Fund for 6 months = $11.25
If you paid the $600 in the first month, you would only have
received 60 shares vs. the 63 you would earn with dollar cost averaging.

 


Things to Note:

  • Dollar-Cost Averaging does not include commissions.  Many use this for purchasing no-load funds Mutual Funds .
  • Dollar-Cost Averaging does not take into consideration inflation; you might have to adjust your investment if it is over years, vs. months.


 

Selling Stocks

My great-grandfather once said "You can't lose money by taking a profit".  No one can always expect to sell a stock at its highest point.  Just like you have to learn when and why you should buy a stock, you need to know when and why it is time to sell a stock.  Even the best stocks do not stay that way forever.  Eventually they too will go down, granted if they are an excellent company they may go up again in the future.  This is why you need to keep an eye on your securities and the market.  You do not want to buy or sell every time a stock goes up or down because then the only one who profits are the brokers on commission.  However, you need to realize when it is time to get out.  Sometimes that will mean a smaller profit and sometimes it can mean a loss.  Many investors stay with a stock too long “because I have taken a loss and maybe it will come back”.  The flip side is maybe it won’t, or it may go down further. It is better to take a small loss than a big one.  But by looking out for signs of weaknesses in a stock or the market, hopefully you can avoid being seriously hurt.  Eventually though, you will have to discover your own signs for when it is time to sell. In part it will be due to how much you can afford to lose. Here are just a few things to look for.

Things to Look For:

  • Fundamental Change:  Are the profits and earnings not as high?  Are they still a leader?  Is their balance sheet as strong? (see some of the above items).  Is the company going in the same direction, or is management changing course?
  • Dividend Cuts:  Dividend cuts are generally a sign that a company is in financial difficulty.
  • What are other people saying?  Are the news and analysts reports as favorable or are they getting negative publicity?
  • Slow Growth:  If the stock is not moving, growing slower than it has historically, you might be wise to sell and reinvest in a stronger security.
  • Overvalued Stock:  When stocks soar quickly past their real value, they are often being set up for a fall.  If you have made a profit, cash it in, you can always repurchase the stock.
  • Keep an eye on the industry and its leaders:  If you have purchased one of the top leaders in a growth industry and the other leaders are starting to slow, it might be time to get out before it happens to your company.  The same holds true if the industry is slowing.
Here are two strategies some investors use when it comes to selling shares:
  • Set a target price:  When you purchase a stock, set a target price to sell both on the upside and the downside, either taking a gain, or cutting a loss.
  • Sell in stages:  Some people will sell part, for example 50%, of the shares of a company if it goes up a certain percentage, say 25%.  This way if the stock reaches your sell stage %, you will walk away with some profit.
Furthermore you have to keep an eye on the broader market and look for signs of both a rising market and signs for a market that has peaked and is on the way down.


 

Stock Splits

Sometimes you will hear the term Stock Splits.  This occurs when a company thinks their share price is too high to attract more investors.  The company will split the stock to create more shares but the market value remains the same.

Let’s say you own 10 shares of High Five Company with the current price of $40 for a total investment of $400.  The company decides on a 2 for 1 stock split.  You then would own 20 shares of High Five Company with a current price of $20, and your total investment would remain at $400.

Sometimes stock splits can lead to short term gain, but not always.  A company’s fundamentals are what will eventually increase or decrease your investment.



 

Calculating Your Return on Your Investment (ROI)

 

We all want to say at the end of the year "how much money did I make".  But many investors do not look at the total picture. Many investors incorrectly state the difference between the buy and the sell price.


For example:  You purchased $500 worth of stock at $25 which equals 20 shares.  You sold it a year later for $30 a share so you earned $100 as profit. This equals a 20% return on your investment. [$500 (original investment) ÷ $100 (profit) = 20%]

However, what if the stock also pays a yearly dividend of 5%?  Which means you would also receive $1.00 per share.  So if you had those 20 shares for the year, you would also receive $20.  Now your total profit is $120 or a 24% return on your investment [$500 (original investment) ÷ $120 (profit) = 24%.


You need to count your dividends even if you reinvest them Stock Dividends & Dividend Reinvestment Plan (DRIP).  You also need to subtract your broker's commissions and fees. Finally, Uncle Sam needs his share.  So you need to calculate your taxes on your investments.  See an accountant for this.

So the real Return on Your Investment (hopefully it will be a positive number) is calculated as: ROI = profits + dividends – commission/fees – taxes.


 

Online Resources for Stock Information