How to Research Stocks    Bookmark and Share

Let's say you have an investment idea. You think that, for example, green energy is the next big thing, and you recently heard a television analyst talking about a specific company that manufactures solar panels. He thinks that this company is in a good position to capitalize on an increasing public demand for green energy sources. Since you think that this stock might have investment potential, you want to do more research. But where do you start?

This is a question that many investors struggle with. There are literally thousands of websites that provide information about stocks. You can find stock screeners, financial documents, analyst reports, charts, industry information, blogs, forums, and much more.

Many investors are overwhelmed by all of this information. Some might not do enough research before buying a stock. Others might spend too much time focusing their research on the wrong things. Yet others might simply hear a stock recommendation from a colorful television analyst and decide to invest in that stock without doing any of their own research at all.

On the other hand, most experienced investors will agree that if you want to be successful, you'll need to do a good deal of research. There are very few serious investors who will invest in a stock without putting in hours, if not days, of research prior to buying a stock. They would also likely agree that not only should you spend a lot of time researching a stock, but that your research should be focused.

But what exactly is focused stock research? Before we address this question, let's gain some perspective by learning a little bit about how the financial industry makes money from you and how this relates to your success as an individual investor.

In the old days, before the internet, there were stock brokers. Your stock broker was in charge of buying and selling stocks for you. It was in the best interest of your broker to have you: 1. Trust him, and 2. Buy a lot of stocks from him, since he earned a commission each time you bought or sold a stock. The whole system was based on trust.

Let's assume that your stock broker made a recommendation about a particular stock, or gave you a "hot tip". He urged you to buy a stock quickly before you missed out on the opportunity. How would you know that the stock that your broker presented in his "hot tip" was actually a good investment? Well, to keep it simple, most people didn't. They had to trust that their broker would recommend the right stocks.

At the time, doing your own stock research was much more difficult. You didn't have access to all of the free information that is now available online. Since your broker was incentivized to make money for himself by convincing you to buy stocks, you couldn't be sure that he had your best interest at heart when he recommended a stock. The only thing that was certain was that he was trying to earn as much commission as possible. The result of this system was that, if you were lucky enough to have a trustworthy broker who made good stock recommendations, you were able to make some money. But if you didn't have a good broker, and you didn't know how to find one, it was much more difficult to invest successfully.

Later, in the 1990's, along came the internet, and with it came a plethora of services and information related to stocks and investing. Traditional stock brokerages slowly gave way to online brokerages. People gravitated to these new online brokers because it was much cheaper, easier, and faster to buy stocks there compared to traditional brokers. A trade that used to cost $100 using a traditional broker might only cost $10 using an online broker, and you could execute a trade with the click of a mouse at the exact moment you desired.

On the surface all of this seemed great. Online brokers not only made it easier and cheaper to buy stocks, but also encouraged people who hadn't previously been investors to begin investing. The problem was that when people began making the switch to online brokers, they no longer had someone to consult with before making a trade. They needed to rely more on their own knowledge and do their own research to figure out which stocks to buy. As a result, although it was now cheaper and easier to buy stocks, it also became much easier to make bad investing decisions. Talk to any investor who rashly invested in a dot.com company that went belly-up in the late 90's and they can attest to this.

On top of all of this, most online brokers, like traditional brokers, wanted you to buy and sell stocks as often as possible. This is because they also made a commission each time you bought or sold a stock. Since they wanted you to trade often, they began to develop "research" tools that encouraged trading and not investing. But why was this a problem? The short answer is that not everyone thinks that trading is a good way to make money. Many people prefer to invest for the long-term, and don't have time to constantly monitor the market for trading opportunities.

To this day, online brokers are virtually the only way that people buy stocks. The tools they offer still focus on trading, and are now much fancier and more complex than ever. They try to convince you that trading is the only game in town, and that you will gain an advantage only by using their proprietary trading tools. Consequently, those of us who invest for the long-term have been left in the dust. Independent-minded investors are now, more than ever, forced to rely on our own research methods and come up with our own rules for what makes a good investment.

Now that we have some perspective on how brokers make money and have established the importance of doing your own research, let's return to the original question, namely: What exactly is the best way to research a stock?

Although I can't definitively answer that question for you, hopefully I can give you a few ideas based on what works for me. The first thing that I recommend is to really think hard about what is important to you in an investment. Think about the information that is available to you and how you can use it to get to the core of what you are looking for in a company. Do you think management is the most important factor in determining what makes a company successful? Or are you a numbers person who likes to pore through the details of financial statements?

Determining what is important to you in an investment isn't easy. If, after spending some time thinking about this, you still don't feel like you know enough about investing to understand what is important, I suggest that you read a book or two on the topic before proceeding. Now, let me share with you a little bit of information about how I typically research a stock. To give you some basic ideas, I have outlined some steps below that I typically use.

  • Review the company's profile and some basic measures. This is a screening step that helps me to get an idea of whether I'm interested in the stock in the first place. There are a number of sites that post basic company profiles.

  • Analyze financial documents, including the balance sheet, cash flow statement, and income statement. This step helps me determine the financial health and overall profitability of a company.

  • Check for revenue and income growth over time. If I see that these measures are increasing over time, it is typically a good sign that the stock price could follow.

  • Research the Industry and Compare the Company to Its Competitors. I like to do some basic research about the competition and industry to gauge whether a company is in a favorable competitive position.

  • Browse SEC filings, including the annual report and recent quarterly reports. There is a good deal of incredibly useful information in these documents that companies are required to disclose at regular intervals.

  • Listen to the most recent investor conference call. The investor conference call is typically held each quarter, following the company's quarterly earnings release. The investor conference call is a great source of both subjective and objective information about a company.

  • Read recent news stories and research recent developments. Understanding what is going on right now with a company is also important to me. Therefore, reading news stories and researching recent developments helps me to gauge if a company is on the right track.

  • Review trading volumes and insider buying activity. I like to look for recent institutional and insider buying.

  • Review key financial ratios and numbers. A few of the key items that I review include the PE Ratio, PEG Ratio, ROI, ROA, ROIC, and a few balance sheet ratios.

  • Research dividend history. The dividend is important to me because I think it tells you a good deal about a company's financial health. I like companies that have been increasing their dividend payout ratio over time.

  • Research the effectiveness of the management team. Does the management team have a solid track record of being able to improve profits? If the management team is new, I like to research their past performance at other companies or in prior roles.

  • Analyze the stock price. I like to look at not just the stock price itself, but also the company's historical stock price compared to its PE ratio. This gives me a better idea of whether I should buy a stock now or wait until it becomes a better value.

While these steps work for me, you may decide that you don't want to use all of them. Or maybe you will decide to use a few steps that I don't use. Regardless of which steps you decide to follow, I encourage you to spend some time and think through what is really important to you in an investment, come up with a series of research steps that you can consistently follow, and then use them each time you research a stock. You will give yourself a better chance of picking quality stocks over time, and will be likely to make more money in the long-run.

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