The stock market turns out to be daunting, particularly when one is surrounded with all the financial jargon. However, this is the real thing: it does not need to be rocket science.
You need not be a Wall Street guru to make wise investment choices whether you are an experienced investor or someone who merely wants to have more than a savings account. Instead, you need a strong framework–which is where this six steps checklist will come in(How I Pick Stocks as a Beginner).
The philosophy of investment guru Warren Buffett is one of the time-tested tips that are the foundation of this guide. It makes the process easy and assists you in analyzing a stock prior to clicking on that “Buy” button.
Let’s break it down.
1. Invest in What You Know
There is a golden rule that must come first before any other rule, and it is the golden rule of investing in what you know.
It may sound self-explanatory, but you would be surprised by the amount of people that pour money into hot tech stocks or complex life science start-ups simply because they are trending on Reddit or CNBC.
Warren Buffett once wrote that he would never invest in a business of which he does not know what is happening–and neither should you. Assuming that you are working in healthcare, say, you already likely know something about that industry. And perhaps you are a coffee-lover, and perhaps you have been observing Starbucks develop over the years, and therefore, you may know more than you realize about its business model.
Stick to what you know well in terms of industries. It prepares you with an advantage and will not leave you in unpleasant surprises in the future.
2. Audit the Financial Health of a Company
Would you lend a friend 10,000 dollars, when they are already in debt and struggling to make the bills? Probably not. The argument is the same with investing in a company.
Have a glance at the financial statements of a stock before investing in it. Yes, this may sound daunting–but it is not as difficult as it might sound. Aim at the three components of financial health:
- Balance Sheet – Informs you on what a company owns or owes.
- Income Statement – It displays the amount of money the company is earning (or losing).
- Cash Flow Statement – Follows the real cash inflows and outflows of the business.
These reports are available publicly to any publicly traded company and once you learn how to read them, you will not need your best friend any more.
3. Look at Key Metrics
Now that you understand what is going on, it is time to dig into the numbers. Certain financial ratios are able to inform you much about a business within a couple of seconds. Here are two to start with:
- Price-to-Earnings(P/E) Ratio: It informs you how costly a stock is relative to how much money the business generates. A high P/E may be an indication that the stock is over priced. A low one could be a bargain–or trouble.
- Price to Sales (P/S) Ratio: In case the company is not profitable yet (as with most startups) the price to sales ratio will give you an idea of how investors are valuing the company on the basis of its cash flows.
You do not have to make you a math genius overnight. All to keep in mind: these numbers assist you in making a calculation on whether you’re paying too much or a good price.
4. Assess the Management Team
Companies are not operated by robots–they are operated by people. It is just logical to take notice of the head of business you are investing in.
Research the CEO and the management of the company. What’s their background? Have they been able to develop other firms? Do they have any scandals or red flags in their history?
This information is regularly available in earnings calls, company bios or financial news sources. A firm that has a good leadership that is experienced will be extremely successful at navigating the ship during good and bad t
5. Determine a Competitive Advantage
Let’s talk moats. Not the sort about castles–the sort that keeps off the competitors of business.
A strong company has a competitive advantage or an economic moat as what makes it stay ahead of the crowd. Consider such businesses as Apple, its base of loyal customers and its closed ecosystem, or Amazon, with its distribution network of immense scale.
Examples of strong moats are:
- Brand loyalty (e.g., Coca-Cola)
- Proprietary or patent.
- A huge and expanding network (such as social media networks)
- Price benefits (Walmart, at least, is victorious in price wars).
When a business possesses a distinct advantage that can not be easily imitated by others, that is an excellent sign.
6. Diversify Your Portfolio
And finally–but by no means the last–do not put all your eggs in one basket.
Although you may identify a company that you love, do not give in to the temptation to go all the way. Even brilliant businesses experience bad seasons once in a while and the stock market itself is unpredictable.
This is why it is so important to diversify. Diversify into other industries and businesses. Even better, when you are starting out and do not wish to select individual stocks; you may want to invest in an index fund such as that of the S&P 500. With a single purchase, it delivers hundreds of companies.
Final Thoughts
Investment is not necessarily a gamble and it is certainly not going to be a nightmare. With this six-step checklist, which includes investing in what you know, checking financial health, analyzing key metrics, researching management, finding a competitive advantage and diversifying, you are able to create a smarter and more resilient portfolio.
Keep in mind that it is not to become a millionaire in one night. It’s to create wealth in the long term with the help of deliberate choices. Get your time, research and do not be afraid to start small.
Also read: Business Ideas that can Start Online in 2025
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