What to Look For When Investing in Stocks - Cabot Wealth Network

What to Look For When Investing in Stocks

Knowing what to look for when investing in stocks will help you focus your attention and lead you to better investment decisions.

Do you know what to look for when investing in stocks? There is an array of information that will help you make better investment decisions consistently. 

One of the first places to look when considering a stock to buy is all of the company’s pertinent information. This information will help you gain the necessary perspective on a potential investment. Begin by looking at whether or not the company has a consistent history of sales and earnings. It is a positive sign if it does. Also consider the company’s customer base and if that is growing or shrinking. This insight can dictate the possibility of the stock increasing or decreasing in value over the short term. 

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What to look for when investing in stocks: Use financial ratios to understand a stock better

There are also financial ratios we recommend using to gain an overview of a stock. Here is a look at those financial ratios:

Price-to-earnings ratio: Also known as the P/E ratio, this is the relationship between the stock’s market price and its earnings per share. There are nuances involving the P/E ratio, but in general, we look for lower P/E ratios over high ones. A stock with a P/E ratio under 10 is typically considered to have strong value. 

Price-to-book value ratio: Also known as the P/B ratio, this ratio looks at the stock’s current market value. The book value is equal to the company’s assets minus its liabilities. To find the book value per share, take the book value and divide it by the stock’s outstanding shares. Then to find the total price to book, dividend the share price by the book value per share. To discover an undervalued stock, look for a P/B ratio under 1. That is the target for investors seeking a value

Price-to-cash flow ratio: Also known as the P/CF ratio, this looks at the relationship between a stock’s price and its operating cash flow for each share. In other words, the ratio looks at a company’s debt in relation to its shareholders’ equity. Operating costs are frequently used with this ratio, providing a look at the value of a company that is not profitable due to non-cash charges. To find the P/CF, divide the share price by the operating cash flow per share. 

Debt-to-equity ratio: Also known as the D/E ratio, this ratio helps understand the overall debt a company faces. To find the D/E, divide the company’s total liabilities by its shareholder equity. The information needed to calculate this information can be found on the company’s balance sheet. 

Debt-to-capitalization ratio: This ratio looks at the overall debt a company has. To determine the debt to capitalization, start by adding short-term debt with long-term debt. You will then divide that number by the short-term debt plus long-term debt plus the shareholders’ equity. 

What to look for when investing in stocks: Seek out dividends

In addition to the financial ratios mentioned above, many investors will look for a history of paying dividends when considering a stock purchase. Although past dividend history does not necessarily mean there will be future dividend payments, it is still a good sign that the company has been able to pay them. Similarly, some industry research shows that companies with favorable dividend policies perform better during both bull and bear markets. 

Look for all of this data to help make more informed investment decisions that will help you develop a diversified portfolio that works for your life. 

What do you look for first when considering a stock to buy?

Nancy Zambell

Secure Your Financial Freedom

Nancy Zambell, Chief Analyst of the Financial Freedom Federation, has spent more than 30 years helping investors navigate the minefields of the financial industry. Nancy's book, Make Money Buying & Selling Stocks is an introduction for new investors and a reminder for experienced investors on how to profit in the stock market.

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