Researching stocks that you're thinking of investing in can be a daunting task when you're new to the process. But learning about stocks isn't as hard as it might seem at first glance. The key is in knowing how to read financial statements.
- To get started with researching stocks, you can read many public financial documents, such as a company's Form 10-K and annual report.
- With a little bit of practice, you can learn how to read the numbers and assess what might be going on within a company.
- Value investing is a method that looks to the company itself to help assess the value of a given stock, not just to the market figures.
How Do I Start Researching Stocks?
If you're like most people, you wouldn't make a major investment in a product without first doing some research. You wouldn't buy a car, for example, without first looking into your preferred model, its price, its value, and its closest competitors. The same applies to stocks. You shouldn't invest in stocks without knowing something about the other companies in the same industry.
Owning stock is nothing more than owning a piece of a business. By law, businesses that issue stock must produce and publish public reports, and those public reports are the perfect place to start when you're choosing which stocks to buy.
Which Documents Should I Research?
Publicly traded companies must file a number of financial documents with the U.S. Securities and Exchange Commission. One is the Form 10-K, an annual report showing the balance sheet, income sources, revenues, and expenses. The narrative section of a 10-K can provide insight into the company's concerns about competition, market conditions, and many other useful pieces of information.
The Form 10-Q is a quarterly update of the content contained in an annual report. It often comes with an earnings call with analysts that can be found on financial websites.
How Do I Read an Annual Report?
Reading an annual report is the key to being able to value a company. Annual reports can be found on the websites of publicly traded companies through the Investor Relations section. With a little bit of practice, you can learn how to look at the numbers and see what appears to be going on within the company. Traders who have been in the game for a while are able to read annual reports and gather insight about many concepts such as accounting goodwill, depreciation, and diluted shares.
The key areas to focus on as you read a report are:
- Revenue: The money coming into a company.
- Net income: What's left after expenses and taxes.
- Earnings and earnings per share (EPS): Company profit on a per-share basis.
- Price to earnings ratio (P/E): The company's current stock price divided by its earnings per share.
- Return on equity (ROE): The profit generated per dollar of shareholder investment.
- Return on assets (ROA): The profit generated from the company's own money.
If you're having trouble reading the annual report, bring it to a financial advisor for interpretation. While you will pay for the time, the knowledge you gain will pay off many times over as you are able to make sense of the details of the report, and use it to make smart investment choices.
What Is Value Investing?
One of the most common and proven stock-picking and investment methods is called value investing. The concept behind this approach is to look to the health of the company to gauge a stock's value, rather than basing your purchase choices strictly on market pricing and other figures.
The value investing approach, whether in its pure or modified form, was started by the famous Benjamin Graham. He came up with seven factors to help find undervalued stocks (or those that are priced well for their earning potential). His approach has allowed many investors to amass fortunes in the hundreds of millions or even tens of billions of dollars, including Warren Buffett.
The Bottom Line
You're ready to purchase stocks after you've done your research, which should start with a deep dive into a company's public documents and reports. You can consult a financial advisor for help, and find out the types of trades you can place at your broker as well.