5 Simple Steps to Research Stocks [with Examples]
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Hey Bow Tie Nation, Joseph Hogue with Let’s Talk Money and those of you out there in the Nation know we love our stock picks here on the channel but I always try to share why I’m picking each and what you need to be looking for.
Because I DO NOT want this channel to be just me telling you what to buy. That does you no good, right? To be dependent on someone else to constantly feed you those stock picks.
I want you to be a better investor. I want you to be able to find the investments that are going to make you rich.
That means giving you the tools to pick your own stocks, showing you how to research a stock from start to finish.
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Is Analyzing Stocks Difficult?
Now for me, that meant studying the curriculum for the Chartered Financial Analyst designation. It meant spending years learning how to dig into the financial statements and analyze a stock. It meant working as a venture capital analyst, creating in-depth cash flow models, industry research and valuations on companies to find the very best investments…
But finding the right stocks to buy doesn’t have to be that intense! In fact, in this video, I’m going to show you a simple, five-step strategy to researching and finding the best stocks. We’ll look at how to narrow your list to a small group of stocks, how to analyze stocks and how to pick the best for your portfolio.
I’ll be using the Stockcard.io platform in the video but the process can be used through any investing site or platform. I like Stockcard because it takes a lot of the ratios and research we’ll talk about and puts it into these easy-to-understand levels for growth potential, operations and valuation.
Not only does the platform make stock research easier, but there are some great tools for starting your stock search and getting ideas as well.
Click through to see how easy it is to research stocks on Stockcard!
How to Start Your Stock Search
Let’s get started and I want to take you through those five steps to research stocks and make sure you’re only investing in the very best. I’ll show you how to start your stock research with a theme or finding the gaps in your portfolio. Then we’ll look at analyzing stocks on four key areas; operations, cash and debt fundamentals for that critical survivability, management effectiveness so you know you’ve got the best team driving those companies, and then valuation so you know you’re getting the best price.
And it’s all got to start with investing in a theme or finding those gaps in your portfolio.
Nation, do not try to pick the best stocks by looking at the entire 6,000-plus trading on the Nasdaq and NYSE. It’s like trying to take a drink from a firehose.
Instead you start with an investing theme or a gap to narrow down your list.
Now a theme is going to be groups of stocks around those universal forces and trends we talk about here on the channel. These are ideas like 5G, artificial intelligence and an aging population. Trends that will shape our future and drive earnings for a specific group of stocks.
I love this type of theme investing because it means you don’t have to find the best of the best within the group. You’re still going to try picking the best stocks but that trend, those huge, unstoppable economic forces are going to be growing sales and earnings for all the stocks in that group. That means you can be off on your analysis and still book some great returns.
Using the gaps in your portfolio to invest is just as important though. This means looking at your current investments by asset class, by stock sector, maybe even by geography and making sure you’ve got a diversified portfolio.
So if you see you’ve got only stock investments, maybe you look for some bond funds or REITs to give you exposure to those other assets. Maybe if you’ve got mostly tech stocks, you look for some strong companies in other sectors like utilities and consumer staples.
Researching Stock Fundamentals to Find the Best Companies
Once I’ve narrowed that stock list to a theme or those in a specific group, I can start my analysis by looking at the operational fundamentals.
Operations are how the company is run, how management is turning the product into sales and earnings so we’ll look at things like sales growth, the profitability margins and profits.
And Stockcard makes this easy, putting all these into these two categories; sales growth and profitability. Here we see the revenue or sales growth for Apple over the last year and the three-year trend.
Now there are two ways to look at any of these and you’re going to want to do both. You want to look at that overall number, so for example the percentage sales growth, but you also want to look at how it compares to other companies in the sector or industry.
I can also click on profitability to see the earnings growth, the trend here and the gross profit margin for the company.
Those of you in the Nation know, I love these margin ratios; the gross margin, operating margin and profit margin. These show you how much money the company keeps after sales at three different points in operations and they’re hugely important to finding the best run companies.
For example, the gross margin is the percentage of sales left after paying suppliers and gives you a picture of how much buying power the company has. The operating margin is the percentage left after paying operating costs like staffing, marketing and administration – this is a great look into management’s efficiency and one of my favorite metrics. Finally, the profit margin is the net earnings, that final income percentage of sales, and gives you an idea of the tax efficiency and use of leverage.
Analyzing Cash and Debt for Stock Investments
After comparing the operations of a company, you move to analyzing the cash and debt fundamentals.
Nation, I always use this entire process to research stocks but sometimes different steps are more important than others. For example, during a recession or as we’re heading into one, being able to analyze the cash power and debt of a company is the most important thing you can do to finding good stocks.
Because if those companies have too much debt or not enough cash to withstand whatever the economy brings, they’re not going to survive for those long-term returns, so here we’re looking at things like Debt Affordability, the debt-to-equity ratio and the current ratio.
For debt affordability here, we’re looking at how much debt the company has compared to earnings, technically here earnings before interest, taxes, depreciation and amortization or EBITDA. We just want to see that the company is generating enough earnings to cover that overall debt.
For the debt-to-equity ratio, this is the amount of debt compared to investors’ interest in the company, so just another way of looking at the amount of leverage the company is using.
This current ratio is a great way to look at the cash survivability of the company. It’s the amount of short-term assets; that’s cash, short-term investments and money owed to the company, really anything that can quickly be converted into cash against the short-term liabilities which are all the accounts the company needs to pay within the next year.
How to Analyze Stocks for Good Management
We also want to look at management effectiveness when researching a stock, how well is management running the company.
I like the operating margin as a way of doing this but we’ve also got the Return on Assets and the Return on Invested Capital for how well management is using the company’s assets and investments to create those earnings.
Most platforms will do the ROA and ROIC calculations for you but return on assets is just the Net Income, that’s earnings, divided by total assets, so how much income is being earned off these assets each year.
The return on invested capital is just the net operating profit after taxes, found by taking the operating income minus taxes, then divided by the amount of invested capital in the company, which is just the long-term debt and shareholders’ equity.
And I know we’re getting a little technical here which is why it’s easier to use a platform that does the calculations for you but it’s also important to know these ratios, what they mean and how to use them to research your stocks.
Using Stock Valuation Measures to Invest
Next here we’re going to look at valuation on the stock to make sure you’re not overpaying for the shares.
Most of you are probably more familiar with the price-to-earnings ratio, that’s the price of the shares divided by earnings, to give you an estimate of how cheap or expensive the stock is. Really though, I like the price-to-sales and price-to-book value multiples much more because they give you a purer look at the stocks value without the accounting shenanigans management plays.
Nation, one of the least understood parts of investing is all the tools and tricks management uses to make those earnings look better. Sometimes that bottom-line earnings per share is all investors look at and a lot of times, it’s tied directly to compensation and stock bonuses, so management has all kinds of tricks they can use to fudge the numbers, some legal and some a little shady.
In fact, most of my time spent as an analyst is rearranging the financial statements for these tricks, getting to the real earnings of the company and seeing through the shenanigans.
So just understand, if you’re only looking at that price-to-earnings number then you’re getting a skewed picture. You want to also look at the price-to-sales and the price-to-book value for a stock because these two, the sales and book value are less easily manipulated by management.
Try Stockcard for free and start finding the best stocks today!
I know it’s more work than flipping to your favorite investing show or just letting some Yahoo in a Bow Tie tell you what stocks to pick, but Nation, knowing how to research your own stocks will make you more money. You’ll be able to pick the investments best for YOUR portfolio and you’ll be a better investor!
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