20 Sep The Investment Strategy
Investors should always keep in mind that when they are buying a stock, they are becoming a part owner of that company. So, short-term market movements aside, the value of the investment depends on the health of the business.
Start with an industry or a company that’s familiar to you. It can be a product which is part of our daily life, a service that we use every now and then. However, avoid the hype. During the dot-com bubble, lots of investors bought stocks without fully understanding how those companies planned to make money. In many cases, it turned out, management didn’t fully understand either.
Investment pros often look for stocks that are “cheap” or “undervalued.” Generally, what they mean is that investors are paying a relatively low price for each dollar the company earns. This is measured by the stock’s price-to-earnings ratio, or P/E. Very roughly speaking, a P/E below about 15 is considered cheap, and a P/E above 20 is considered expensive. Compare a company’s P/E to other companies in the same industry to see if it’s cheaper or more expensive than its peers.
Start digging into the company’s financial reports. Don’t just focus on the most recent report: What you’re really looking for is a consistent history of profitability and financial health, not just one good quarter. Anything can happen day to day, but in the long run, stock prices increase when companies are making more money, which usually starts with growing revenue. The difference between revenue and expenses is a company’s profit margin. A company that’s growing revenue while controlling costs will also have expanding margins.
The share price of a company with more debt is likely to be more volatile because more of the company’s income must go to interest and debt payments. Compare a company to its peers to see if it’s borrowing an unusual amount of money for its industry and size.
A dividend, a cash payout to stock investors, isn’t just a source of regular income, it’s a sign of a company in good financial health. If a company pays a dividend, look at the history of their payments. Are they increasing dividend or not?
Of course, you should have a plan for how you approach buying stocks, but it’s just as important to know when to sell. Have a set of criteria that will tell you it’s time to sell: If the company cuts its dividend; if the price rises or falls to a certain point; if an analyst downgrades the stock, and so on. Having a plan for selling will help you avoid selling out of panic over a short-term move in the market. A plan for selling can also help you take your gains.