Investing in a company's equity, i.e. buying stock, is the riskiest yet most advantageous position you can put yourself in. There's no other financial force that can take your investment and turn it into an unlimited potential profit. However, everyone knows that buying stock does not always reap rewards and, in fact, you can experience some serious losses should the company, or the overall market, falter in any way. So how do you pick a stock that provides for a healthy upside yet limit the downside?
The most fundamental question is to ask yourself why you're buying stocks, rather than bonds or high-yield money markets. It should be more than just to seek a quick profit. As attractive as that sounds, it usually turns out to be a losing strategy because a short time frame means that you're not actually investing but rather stock trading. If you truly consider yourself an investor then allowing the company to emerge based on the rationale for investing in the first place will serve your long-term investment goals.
The next question is to analyze your financial situation. Can you afford to take a loss? What's the time horizon on these investments; when do you need this money back? You should only buy stocks if you're willing to take the associated risks. What's your risk tolerance and do you have any specific philosophies toward investments, i.e. socially responsible investing? Once you answer these questions then now you can start picking your stock.
Before you pick a random stock, it's important that you know the market. Warren Buffett famously said, “Never invest in a business you cannot understand." U.S. large company growth stocks typically create aggressive capital returns but do not pay a dividend while value-oriented stocks can offer often 2-3% annual cash dividend on top of a capital return. Value stocks, like utilities, banks, and energy companies, have a long history of slow yet profitable growth. “While the S&P 500 Index plunged more than 50% during the financial crisis, the [value] stocks we hold would have delivered steady dividend income during this period.”^1 If you're of moderately conservative risk tolerance, then this may be a prudent start to your portfolio.
There are a few approaches to help you decide if a particular stock is right for you. Fundamental analysis will help you understand the company's financial strength and its potential for future growth while technical analysis can help you understand the stock's behavior in charts for its supply and demand component.^2 Then apply a qualitative overlay: does the company provide for seismic R&D and innovation potential to the marketplace?
Despite all the due diligence you can do on a particular stock, know that a systematic market event could take down your stock along with everything else.
At Eureka Wealth Management, I screen for fundamentally sound companies and chart them to see if they're technically supported before I buy them. I leverage research papers and newspapers, such as Investors Business Daily and the Financial Times, to help start my screens. I also execute trades and provide for semi-annual investment rebalancings and reviews with my clients. Call for a free initial consultation at (760) 537-0791 or online at eurekawealthmanagement.com.
^1: Living off dividends in retirement: https://www.simplysafedividends.com/intelligent-income/posts/1-living-off-dividends-in-retirement