How to choose stocks for investment: 7 indicators for assessing quality and profitability

Every investor, both a beginner and an experienced player on the stock exchange, should know how to choose the right stocks. Typical mistakes of beginners are to choose securities based on the reviews of sofa experts on the Internet, recommendations from friends, and even names. This approach is high-risk and does not exactly fit the definition of a professional investor.

If you have chosen economic, pharmaceutical, or transportation stocks to invest in, you should have an effective buying and selling strategy. It involves a deep understanding of the pricing, types, quality, and profitability of stocks. Otherwise, the whole process turns into chaos, not unlike buying lottery tickets.

How to make the right choice?

To choose the right stocks, you need to study two parameters: the company and the stock issued by it.

The first criterion will allow you to refuse obviously unprofitable investments, and the second will allow you to get an idea of the actual value of stocks, thereby minimizing the risk of buying overvalued assets.

Company analysis

The study of the company is primary when choosing stocks. Experienced investors recommend paying attention to the following indicators:

  1. Turnover is the company’s revenue from the sale of goods and services.
  2. Gross profit is the difference between revenue and cost of finished products.
  3. Operating income is the earnings of the company from primary activities. The formula for the calculation is revenue minus cost minus direct operating expenses.
  4. Net profit is operating profit minus mandatory contributions to the state budget and funds.
  5. FCF – cash that remains at the disposal of the company after deducting the costs of maintaining or expanding assets.
  6. EPS – the ratio of the company’s net income to the number of ordinary shares in circulation.

All indicators can be found in the company’s profit and loss statement. Choosing stocks based on the company’s financial results is the first step to understanding the essence of the investment process.

What to pay attention to?

There are several effective ways to choose stocks wisely. Experienced investors prefer to use proven methods. The concepts are different, but the essence is the same – a thorough analysis of financial performance. Basic principles:

  1. It is necessary to choose the shares of only those companies whose business is clear to the investor and study goods and services on the market – their popularity, stability, and period of existence.
  2. Conduct an analysis of the financial performance of the company (data from the balance sheet). Analytical studies include earnings quarterly, annual, per share, etc. It is recommended to give preference only to those companies in which revenue growth is at the level of 25% per year.
  3. Study the distribution of shares among investors. If a large stake is owned by a corporation with a worldwide reputation, then the shares deserve attention.

Company management

When analyzing a company, it is important to study the owners and management. The prosperity of the enterprise depends on the administration, which carries out competent management.

Therefore, stocks should be selected based on the following indicators of the management team:

  1. The period of time the chairman of directors holds office.
  2. The main financial results of the company during his reign – were profit, revenue, share price, and profitability.
  3. Profile education of key executives, work experience in other companies, achievements, and serious failures.
  4. The number of shares held by management, purchase frequency.

Price

The main mistake of beginners is to choose stocks by value. This is a fundamentally wrong approach. A low share price can be both a temporary phenomenon and an indicator of the company’s negative development. The value of the business or the capitalization of the company is the main criterion to be guided by when choosing stocks.

Quality

The profitability of a business is a direct indicator of the quality of a company. An investor cannot define market capitalization and ignore quality, or vice versa. To evaluate a company according to this criterion, you need to know how long it will take for the money invested to fully pay off. There are two options:

  • the company compensates for investments by paying dividends, allocating funds from net profit;
  • the issuer invests all profits in the development of the business, as a result of which the market capitalization and the stocks increase in price. As a result, the purchased block of shares will cost more.

To evaluate quality indicators, there are special formulas or multipliers.

News

Issuing companies are required to report in the “Investor Relations” section. But companies are constantly publishing news to keep stocks in a certain price range. Each excitement on the stock exchange is reflected negatively or positively on the quotes of stocks. Company news is the primary source of these fluctuations

News is published on the official websites of the issuing companies. The investor must constantly monitor events so as not to miss important information. Be sure to pay attention to the launch of a new product or the renewal of an existing one, the opening of branches, the introduction of technologies, and the change of leaders (managers, directors). All economic actions of the company affect the value of stocks.

Profitability

To correctly select stocks, several profitability estimates are used:

  • ROE;
  • ROA;
  • ROIC;
  • CROIC.

Dividends

This is the most important criterion when choosing stocks for long-term investments. The company has the right to independently decide what part of the net income will be distributed among shareholders. This issue is resolved annually by the board of directors, and the results are announced at the general meeting. Therefore, it is worth choosing stocks of those companies that consistently and consistently pay dividends.

Final thoughts

The choice of stocks is an important and voluminous topic that requires in-depth study from a novice investor. Investment goals, strategies, company quality, and multiples are all important components of successful investing. If you want to save time and still benefit from investment recommendations based on powerful market analysis tools, Gainly is the perfect solution for you. For example, if you plan to invest in stocks of transport companies, the Gainly application will help you create a personalized ranking of the best companies in this industry, and quickly respond to changes that may affect the value of stocks.