How to Invest in Stocks For Dummies

Checking Important Company Fundamentals before Investing in a Stock

Before you buy stocks, you have to do a little research on the companies you’re thinking of investing in. Pay attention to the following key components when you look at a company’s main financial statements

• Earnings: This number should be at least 10 percent higher than the year before.
• Sales: This number should be higher than the year before.
• Debt: This number should be lower than or about the same as the year before. It should also be lower than the company’s assets.

Financial Measures to Consider before Investing in a Stock

You’re thinking of buying stock in a company, but before you invest your hard-earned money in hopes of a profitable return, check out some financial ratios that can help indicate whether the company is on sound financial footing. Here are key measures to consider:

• Price-to-earnings ratio (P/E): For large cap stocks, the ratio should be under 20. For all stocks (including growth, small cap, and speculative issues), it shouldn’t exceed 40.
• Price-to-sales ratio (PSR): The PSR should be as close to 1 as possible.
• Return on equity (ROE): ROE should be going up by at least 10 percent per year.

• Earnings growth: Earnings should be at least 10 percent higher than the year before. This rate should be maintained over several years.
• Debt-to-asset ratio: Debt should be half of assets or less.

The 10 Most Important Points about Stock Investing

1. You’re not buying a stock; you’re buying a company.
2. The primary reason you invest in a stock is because the company is making a profit and you want to participate in its long-term success.
3. If you buy a stock when the company isn’t making a profit, you’re not investing — you’re speculating
4. A stock (or stocks in general) should never be 100 percent of your assets.
5. In some cases (such as a severe bear market), stocks aren’t a good investment at all. A bear market, however, may offer buying opportunities for profitable companies.
6. A stock’s price is dependent on the company, which in turn is dependent on its environment, which includes its customer base, its industry, the general economy, and the political climate.
7. Your common sense and logic can be just as important in choosing a good stock as the advice of any investment expert.
8. Always have well-reasoned answers to questions such as “Why are you investing in stocks?” and “Why are you investing in a particular stock?”
9. If you have no idea about the prospects of a company (and sometimes even if you think you do), use stop-loss orders or trailing stops.
10. Even if your philosophy is to buy and hold for the long term, continue to monitor your stocks and consider selling them if they’re not appreciating or if general economic conditions have changed.