How to Research Stocks and Choose Good Investments

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Researching stocks that you're thinking of investing in can be overwhelming and intimidating when you're new to the process. But researching stocks and investments isn't as difficult as it might seem at first glance. The key is to understand how to read financial statements.

How to Start Researching Stocks

Most likely, you wouldn't make a major investment in a product—say, a car—without first doing some research on your preferred model and its closest competitors. The same applies to stocks. You shouldn't invest in stocks without knowing something about the other companies in the industry. 

Owning stocks is nothing more than owning pieces of various businesses. Businesses that issue stock are required to produce and publish public reports and those public reports are where you should begin when you're deciding which stocks you should buy. 

Documents to Research

Publicly traded companies must file various 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 other useful information.

The Form 10-Q is a quarterly update of the information contained in an annual report and is typically accompanied by an earnings call with analysts that can be found on financial websites.

Reading a Company's Annual Report

Annual reports can be found on the websites of publicly traded companies through the Investor Relations section.

One way to accelerate your understanding is to bring an annual report to a financial adviser for interpretation. While you will pay for the time, it will come back to you many times over as you are able to make sense of the publicly available information.

Reading an annual report is the key to being able to value a company. 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. Concepts such as accounting goodwill, depreciation, and diluted shares outstanding will begin to make sense.

Key areas to focus on are:

  • Revenue: Money coming into a company
  • Net income: What's left after expenses and taxes
  • Earnings and earnings per share (eps): Company profitability on a per-share basis
  • Price/earnings ratio (P/E): Company's current stock price divided by its earnings per share
  • Return on equity (ROE) and Return on assets (ROA): ROE is profit generated per dollar of shareholder investment. ROA is profit generated from the company's own money.

Value Investing

One of the most successful stock-picking and investment methods in history is value investing.

The value investing approach—either in its pure or modified form—was started by the famous Benjamin Graham. Read up on his seven investment secrets before you get started. His approach has allowed many investors to amass fortunes in the hundreds of millions or even tens of billions of dollars, including Warren Buffett, John Templeton, Peter Lynch, Charlie Munger, Bill Ruane, Eddie Lampert, Lou Simpson, and the guys at Tweedy Browne and Company.

Buying and Trading Stocks

You're ready to begin purchasing stocks after you've done your research, which includes an understanding of the difference between a market order and a limit order, and a few basics about options, shorts, margins, and other stock-buying concepts. Find out the types of trades you can place at your broker as well. 

NOTE: Please consult with a financial adviser for the most up-to-date advice and answers to any specific questions you might have. The information contained in this article is not intended as investment advice and it is not a substitute for investment advice.