How To Do Your Research Before Buying Stocks
Choosing the best stocks can seem like a daunting process for individual investors. However, if you'd like to manage your portfolio, you can utilize the same methods that Wall Street AND NSE experts do for their research and analysis.
Not sure where to start? Use these 5 stages as a roadmap for choosing which stocks to invest in.
Stage 1: Understanding the Types of Stock Analysis
Understanding the various stock analysis kinds is the first step in conducting stock research. The three primary categories of analyses used in stock research are:
- Fundamental Analysis: helps you forecast performance by looking at fundamentals like earnings, cash flow, and financial situation. To get started on fundamental analysis, you must key Nigerian and global financial publications such as Nairametrics, Wall Street Journal, etc.
- Technical analysis: Predicts future price movements by using historical prices and trade patterns. A good place to get started with technical analysis would be to take courses on stock trading (on YouTube or elsewhere).
- Quantitative analysis: Determines a stock's value using mathematical and statistical modeling.
Every approach has its advantages. Fundamental analysis should, however, typically be your main tool for determining the worth of a certain asset. This is due to the way fundamental analysis dissects a company's real-world performance. On the other side, technical analysis can highlight price abnormalities in an asset. But things can happen for a variety of factors, including negative press coverage.
To decide whether a stock is a viable investment opportunity, quantitative analysis may utilize some of the same metrics as technical analysis and may also employ statistical modeling.
A quick tip: Start your analysis by assessing a company's fundamentals, such as earnings, profit margin, and revenue growth. You can then use qualitative and technical analysis to supplement your fundamental analysis to gain deeper insight.
Stage 2: Establishing Your risk Tolerance and Budget
Before doing any stock research, it's critical to determine your risk tolerance and budget. There are numerous different stock types, and there is almost no cap on the amount you can invest.
Blue-chip companies, like those in the Dow Jones Industrial Average, may, for instance, offer a steady return but lack the same upside potential as a startup. However, a startup will naturally have a higher possibility of doing poorly or even failing. You must therefore strike a balance between the amount of risk you are willing to take and the kind of return you anticipate.
Willingness to bear risk, on the other hand, is more subjective. One way to gauge your willingness to bear risk is to simply ask the question: ‘If your portfolio suddenly declined by X percent, would you lose sleep over it and suffer substantial regret?’ If the answer switches from yes to no when X is 10 percent, then you have very little willingness to bear risk, and quite frankly, have limited investment options.
Another factor is your budget. A 10% return on a $1,000 investment and a 10% return on a $100,000 investment are different. In other words, if your budget is modest, you might have to take on greater risks to achieve your desired returns. However, that is not unusual, as people who are just starting in their careers typically have less money to invest but also have more time to take risks. The foundation of any financial strategy is knowing where you fall on this spectrum.
Stage 3: Knowing Which Investing Metrics to Pay Attention To
There's no shortage of investing metrics available, especially for stocks of larger, well-established companies. Some are more critical to your chances of success than others. Key metrics to consider include:
- Price/earnings ratio
- Return on equity
- Net profit margin
- Price/book ratio
- Free cash flow
- Return on assets
Which metrics are most important depends in a large part on the style of investing you prefer. For instance, two common forms of investing are value and growth investing. Value investing involves buying stock in companies that are undervalued, therefore selling at a discounted rate. Growth investing, on the other hand, means buying stocks of companies that are expected to grow at a rate faster than the market. The measures that matter the most to you will mostly rely on the investing approach you like. For instance, value and growth investing are two popular types of investing. Purchasing stock in undervalued companies that are then sold at a discount is known as value investing. On the other side, growth investing is purchasing shares in businesses that are anticipated to grow faster than the market.
Value-oriented investors tend to focus on price-to-cash flow, price-to-book, and other measures that suggest a depressed price compared to the normalized earnings or intrinsic value of a business which creates a margin of safety. In other words, for value investors, the key metrics are those that indicate a price is lower than competitors' stocks, such as price-to-earnings or price-to-book. For this kind of investor, the lower these ratios are, the better.
Growth investors take an entirely different approach from value investors. Growth managers tend to focus on earnings and revenue growth with less focus on metrics like price-to-earnings as they expect the earnings to increase over time to justify the price. Oftentimes, growth stocks are companies that have not fully matured, so earnings and revenue growth are more important than price.
Stage 4: Finding the Data You Need to Start Your Research
Now that you have an idea of which companies you want to analyze, it's time to dive deeper. Here are some of the reports, documents, and tools you may want to check:
- SEC/NSE/CBN reports
- Online brokerage research platforms
- The company's revenue and income
- Company press releases
- Industry trends
- Stock screeners
You can check each firm when you first begin your research on the research platform of an online brokerage or in-stock screeners. Then you can delve further into the reports on the businesses that seem promising.
There is no shortage of reports and data to detail the companies you are considering for investment. However, there are certain places you should first direct your focus. Any company that you're looking into usually has an investor relations section on the website (for global stocks). If you go there you can find any important press releases, financial documents, and documents filed with the SEC. For Nigerian stocks, you may have to settle for industry trends or, better still, request the specific document you need from the NSE/SEC using the Freedom of Information request.
Stage 5: Narrowing your focus and pick stocks that fit your portfolio
There aren't any "magic bullets" that fit perfectly into your portfolio, as you have probably already realized. Instead, you ought to seek out investments that most closely match your investment objectives. For instance, do you favor growth or value investing? What is your risk tolerance and what is your budget?
You may begin developing your investing strategy once you have the answers to these questions. Value investing benefits more from certain criteria like price-to-earnings, whereas growth investing benefits more from metrics like profit margin. The correct stocks for you can then be found by focusing on a business's fundamentals using an online broker and company reports.
You can evaluate a stock's risk level in relation to your risk tolerance and spending limit to decide whether to invest and if so, how much. After that, you can keep assessing the company using upcoming quarterly and annual reports to make sure it still conforms to your strategy.
The financial takeaway
It can seem intimidating to conduct stock research, but it doesn't have to be. Determine your budget, risk tolerance, and desired investment style first. Then, to learn more about each stock you are considering, use an internet broker as well as internal and external corporate filings.
When you've finished, you're prepared to begin investing. Make sure to keep assessing each of your investments, whether it be quarterly or yearly. If a company no longer aligns with your strategy, you might want to make changes; just be careful of potential capital gains taxes if you decide to sell.