Today I want to talk about investing in individual stocks. Owning a share of stock means that you are directly investing in one specific company. In essence, you could say you are part owner of the company. By buying their stock, you are effectively loaning the company money to (hopefully) make a profit, so that you end up with more money than you started with.
Investing in a company’s stock can be inherently more risky than investing your money in a Mutual Fund or ETF. Because you are putting your eggs in one company’s basket, your financial outcome is linked directly to the success (or failure) of that company, whereas with a mutual fund or ETF, your money is spread among many companies and/or asset types. Because of that, I limit my exposure to individual stocks to 5-10% of my overall portfolio.
Before I dive into this post, I want to clarify that my intention here is not to give you hot tips on finding the next big stock. I’m also not talking about timing the market because, well, I don’t think that’s a good idea. Rather, I want to share some tools that have helped me pick a handful of stocks to follow, buy and hold for the long term. I hope you find them helpful, too.
It should also be said that individual investors (and most professional investors) generally don’t beat the market by buying and trading stocks frequently; buying and holding an index fund or ETF is a better bet. That being said, I think stock picking is kind of fun and am willing to take a little more risk to pursue it.
When looking at an individual stock, I first make sure to understand the overall market plus the specific industry the company operates in. That means looking at things like:
- Gross Domestic Product (GDP): GDP measures the size of the overall economy compared to the same time period in the previous year. It is expressed as a percentage; a positive GDP indicates the economy has grown where a negative GDP number means it has contracted. Positive numbers are generally good for everyone, as it means companies (and therefore investors) are likely making profits.
- Price-to-earnings ratio (P/E): This number is a quick way to assess the company’s earning potential relative to the stock price. The higher the P/E, the more likely to have higher earnings. You need to compare to the industry’s P/E to make this number meaningful, as a “high” P/E is different for every sector. This Yahoo site shows you average P/E (and many other metrics) for a long list of industries. You can find a company’s P/E by plugging in their stock ticker to any financial site – it’s in the header information.
Beyond these measures, I try to read as much news and information about a specific company as I can to get a sense of their outlook and reputation. Look in the “investors” section of their website for financial releases and reports. My rule of thumb: don’t buy a stock for a company if you don’t understand the business or industry they are in. Otherwise how will you be able to honestly assess it to buy or sell?
If I’m picking a stock, I usually look for stead growth and low volatility, or price swings. There are two ways I like to look at the volatility of a stock:
Beta measures the stock’s performance against the overall market. The market’s Beta is always 1.0, so a stock with a Beta lower than 1.0 is less volatile than the market, where a Beta higher than 1.0 is more volatile. You can find a stock’s Beta on any finance site by plugging in the ticker symbol; the Beta is usually in the header information next to the price:
Simple Moving Average
The second measure of volatility I like to look at is the Simple Moving Average. This is a little more involved to track. The best tool I’ve found is Google Finance, as you can fairly easily turn on this information from the stock’s main page. Plug in the stock’s ticker symbol. Then, from below the graph area, select “Technicals.” From the pull down menu that appears, select “Simple Moving Average” and input “20” next to “Period.” “Add Technical” two more times with “50” and “200” for your periods. From the top of the graph, “Zoom” to “6m,” like this:
This will add three colored lines to the graph. Explained in the simplest terms, what you’re asking Google to show is the closing price of the stock averaged over the respective trailing time periods (20, 50, and 200 days).
What I look for with these graphs is to see that the lines generally don’t crisscross each other a lot, with the most important being the 20- and 50- day not crossing the 200- day. I want to see the 200-day line on the bottom, 50- in the middle and 20- on the top most of the time. That indicates the stock price is generally fairly stable.
Once I’ve picked a stock to follow, I use tools like Google Finance and a stock tracking app on my phone to watch how it does (I use “Real-Time Stock Tracker”). If the stock has a big jump or dip in price, I try not to panic and do some research to understand why. This helps me sort out what the major influences are on the stock price. But I try not to get too obsessive with it; I check it about once a month.
Do you have other methods for assessing stocks? Share them in the comments below!
Please note: I am not a financial expert and speak to financial topics from my own personal experience. Please consult a financial professional before making any of your own personal financial decisions.