How do you pick stocks to buy? What is the difference between fundamental investing and technical investing? Which strategy is the best amongst the two? Which strategy has performed better in the long run? Well, I advice you read on to find the answers you seek.
Good traders / investors do not just buy stocks on impulse or because they heard good news about them, they research and study them first before deciding on which to buy. Keep in mind that the stock market is a relatively unpredictable place; it is not guaranteed that if you buy stocks you will automatically make money.
If you make the wrong decision on your choice of stocks there is a chance that you will lose rather than make money. So to help you make the correct choices, you need to understand how to conduct stock market research.
Table of Content
- What is Stock Market Research?
- What is fundamental investing?
- How to Pick Stocks to Buy with Fundamental Analysis
- Factors That Fundamental Investors Look Out For Before Picking Stocks
- Stock Investment Strategy – Technical Analysis
What is Stock Market Research?
Stock market researching is an intricate process wherein you need to analyze and study the company whose stocks you are interested in buying. You need to study a lot of fundamentals, charts and graphs so that you can get a grip on how the company’s stocks move, and whether or not it is the right time to invest. It is a rather complex task, but it is doable.
How to Pick Stocks to Buy as a Beginner
a. Look for Stocks that Are In Your Price Range
You cannot invest in a company’s stock if you cannot afford to buy even a single share. Most beginners at stock trading think that they need to get some stocks of the big companies because they are the ones that have real promise; when actually they are very far from the truth. Huge, successful companies’ shares run at more than $300 to $500 per share, too high for beginner traders or investors.
The first thing that you need to do first is look for companies whose stocks fall into your price range; they may not be as secure as those of the big companies, but at least you can buy a sufficient amount that can yield substantial profits.
b. Do an In-depth Study of the Company That Caught Your Interest
Once you have found stocks that fall within your budget, you need to find out if the company is really worth your investment. Look for any news regarding the company. Any information you can dig up will be useful, like how many years has the company been in operation, where do they get the bulk of their funding, what are their top-selling products or services, things of that nature.
These bits of information can give you a rough idea of the company’s potential for growth and how soon you will be making money if you so choose to buy some of their stocks. You should never entrust your money to a company that you have no information on. That is one of the fastest ways to lose money in the stock market. The basic principle of stock market research basics for beginners is learning all you can about the company that grabbed your interest.
Of course, you have the freedom to look at the list of companies in the stock section of your local newspaper, choose a company at random without considering any factors, and proceed to invest in that company’s shares. But I am sure you won’t do that. If you do, you would be badly burned (unless you luckily chose a company with profitable shares) because you only gambled.
Investing is very different from gambling; so, investors don’t adopt the gamble approach I described above. Rather investors approach the stock market in two primary ways; fundamental investing and technical investing. Every investor will make a decision based on one of these two analytical approaches, as they are the basis of rationale in the markets. So, in this post, we will be discussing each approach in full detail and then state the strengths and weaknesses of each.
Now how do you invest in a company with a solid track record, a good management team and strong customer and shareholders confidence? How do you make money in the stock market without having to follow the price of stocks daily? How do you invest with minimum risk and less emotional traumas? The answer to these questions boils down to investing with “Fundamental Analysis.”
The best way to understand fundamental analysis of stocks will be through comparative explanations. Imagine two fish dealers in your nearby marketplace. Fish Dealer 1 is selling moderately priced fish while Fish Dealer 2 is selling fish of more affordable value.
Let’s suppose you are the buyer and intend to get a fish you will cook for dinner. The first thing to come in mind is which one is cheaper, but this will immediately be followed by the thought of which is a better fish. This is the basis of fundamental analysis.
What is fundamental investing?
Fundamental investing simply means making a decision to buy stocks after carrying out a fundamental analysis of the stock market. Similarly, technical investing is when you buy stocks after conducting a technical analysis of the stock market.
Fundamental analysis of business is the scrutiny of stocks to gauge a business in terms of its profile which includes its structure and management and comparing these stocks with other companies in the market that offer similar products or services. If you are the buyer and you see that Fish Dealer 2 offers more affordable fish, would you be buying his products immediately?
The answer will depend of course on a variety of factors like whether he offers fresh fish, whether what he has is the same as with Fish Dealer 1, or whether he just wants to sell his products that he lowered down his prices. Like fundamental analysis of stocks, price of stocks in itself will not easily determine the salability of it. This is where several statistical tools can be used to delve into the real situation and what best to do in response to the findings.
How to Pick Stocks to Buy with Fundamental Analysis
As stated earlier, fundamental investing follows fundamental analysis, which looks at the underlying financial strength of a company. In other words, when you try to analyze the financial strength of a company before making an investment decision, you are engaging in fundamental analysis. Fundamental analysis is all about making financial forecasts based on historical and present data.
In this case, factors such as stock prices, shares, earnings, and other economic indicators like inflation rate, exchange rate, and interest rates all are taken into consideration in buying or selling stocks. Earnings per share, price to earnings ratio, projected growth in earning and return on equity are only few of the many key tools to consider in analyzing stocks and require the expertise of financial analysts or statisticians in order to best assess a business’ performance, stability, or growth.
In order to understand how strong a company is, you need to study the company’s past and present financial statements or reports. These reports contain the company’s balance sheet, income statement, and cash flow statement and they allow prospective investors to peek into the financial health of the company.
Before you pick where to purchase fish, you already have in mind what kind of fish you will be buying, how many of it you will buy, and for what use it will be. Just like in buying stocks, you already have a picture of what you want. Market figures and economic indicators will then serve as guides as to which better stocks to pick. Just like in buying fish, you might consider checking which fish dealer has the more customers or which has more products to sell.
With the information contained in a company’s financial statements, a fundamental investor determines the P/E ratios, current ratio, return on assets, profit margins of the company, return on equity, and other factors that will facilitate a well-informed investing decision. Aside a company’s financial report, a fundamental investor also considers the country’s economic state before making an investment decision.
Fundamental investors look into interest rates, exchange rates and government policies on an industry. Using simple comparative approach, understanding fundamental analysis of stocks gives clearer picture as to its complexity. Fundamental analysis is very important as it creates an overall impression on a business’ health and so poor statistical figures may cause loss of investor confidence leading to financial losses.
Factors That Fundamental Investors Look Out For Before Picking Stocks
- Economic conditions
- Exchange rate / interest rate
- Inflation rate
- Fiscal / monetary policy
- Government policy
- Price to earnings ratio
- Earnings per share
- Dividend yield / dividend payout consistency
- Political stability
- Industry trends / happenings
- The competence of the management
- Quarterly / annual reports / historical data
- The rate of return in the money market
- Foreign direct investment
Even though the financial strength of a company remains most important, economic factors cannot be overruled. No matter how impressive the results of a fundamental analysis of a company may be, there’s no guarantee of positive results in the future. Warren Buffett has been acknowledged as one of the world’s best fundamental investor.
In conclusion, as a seller of stocks, it is essential to invest on researches for business development in order to maintain investor confidence, business growth, and eventual success. As a buyer of stocks, it is necessary that proper guidance be set to prevent money loss.
Fundamental Analysis – 3 Lessons from Warren Buffett Investment Strategies
1. Think Different
“Be fearful when others are greedy and be greedy when others are fearful.”
This quote describes his investment strategy very well. He was famous for avoiding investments in technology companies during the Tech Bubble in the late 1990s when almost all of Wall Street was loading up on Tech stocks. Of course, when the Bubble burst, Buffett got the last laugh. Buffett is known for finding hidden gems that few others know about because he knows that those kinds of businesses usually make the best investments.
When Facebook was going public a few months ago, he publicly stated that he will not be buying its shares, while everyone else believed the hype and couldn’t wait to load up on Facebook shares. Needless to say, Buffett was right again.
2. The Stock Market is Not There to Instruct You
Many stock market investors and day traders treat the stock market as something that will influence them to make their decisions about which companies to invest in. This is a very bad idea. As Buffett famously says,
“The market is there to serve you; and not to instruct you.”
This means that the stock market is simply there to facilitate the trading of stocks and not influence the decision-making of investors. The only factors that should determine whether a company would make a good investment are the company’s merits, not its stock chart, volatility, or its trading history.
An example of this would be when Buffett decided to invest in Goldman Sachs, an investment bank, during the financial crisis in 2008 when all banks were plummeting and on the verge of filing for bankruptcy. Even after Buffett invested, the stock price of Goldman Sachs continued to drop and investors thought Buffett had lost his touch but Buffett didn’t let that bother him and sure enough, the stock price eventually rose and Buffett made billions from the investment.
3. Stay Inside Your Circle of Competence
Buffett is a strong component of “invest in what you know”. He doesn’t invest in companies or businesses that he doesn’t understand; which is part of the reason why he has avoided investing in many technology companies. A few years ago, he invested in a railroad company, which many others deemed strange in a society where technology companies dominate the media, but the investment has turned out really well.
In fact, many of Buffett’s best investments are in industries that would be considered “old” such as chewing gum, metals, beverages, insurance, clothing, newspapers, etc. The lesson here is to stay inside your circle of competence and invest in companies that you understand rather than speculating and investing in “hot stock picks” that your broker is giving you.
Stock Investment Strategy – Technical Analysis
A technical investor, instead of looking into a company’s financial strength, studies charts that reveal certain vital information about a company’s stocks. These charts are derived from very complex mathematical formulas, and they reveal anything from the company’s share price to moving averages, volume, relative strength index, and so on.
Technical investors make their decisions based on the information provided by a company’s charts, with the belief that all the information they need about a company’s financial footing has been factored into the charts. So, there’s no need to look at financial statements or economic factors. In short, technical analysis seeks to predict future price moves.
A technical investor wants to take advantage of these price moves and turn them into profits. So, when you hear finance news broadcasts stating parameters such as breaking points, double tops, resistance lines, moving averages, double dips, and so on, they are only revealing vital information to technical investors.
Factors That Technical Investors Consider Before Picking Stocks
- Moving average
- P/E ratio
- Book value
- Liquidity ratio
- Daily volume
- Bid / offer rate
Other Factors that Affect the Price Movement of Stocks
- News about public offers, dividends, bonus
- Quarterly performance
- Mergers and acquisitions
- Change in government policy
- Exchange rate
- Interest rate
- Change in economic / fiscal policy
- Political instability
- Change of management
In technical investing, the charts of any company are analyzed, and no specific companies are preferred. Technical investors only need an emerging pattern that they can take advantage of. They find companies with highly volatile stocks and try to make profit from price fluctuations. Therefore, technical investing is very tedious and complex. Like fundamental investing, technical investing does not guarantee positive future results. George Soros has been acknowledged as one of the world’s best technical investor.
3 Basic Assumptions of Stock Market Technical Analysis
As opposed to fundamental analysis, technical analysis of stocks is a lot easier; depending on your own investment perception. While fundamental analysis gives too much attention on the “value” of a stock and the corresponding management team, technical analysis is more concentrated on the movement of prices in the market.
It mainly focuses on supply and demand to determine past patterns and predict what market direction or trends will ensue. Both of these have direct effect over stock prices. Technical analysis runs in 3 assumptions.
a. Stocks Move in Trends
First supposition is that stock prices move in trends. It is believed that the future movement of prices can be foreseen through examination of current pricing and market trend and such can be affected by supply and demand. To understand this better, picture yourself as a fruit harvester who sells at your local marketplace. In order to sell products, you either price your items the same as your competitors or at a slightly lesser amount.
If you have observed that for the past few months, prices have remained constant for the same products, the most likely thing is that this will ensue for another few months unless, for instance, external factors like inflation or weather changes intervene. This is the basics of technical analysis, where you study trends and charts, and monitor demand, supply or market emotions; so as to exploit them to your own advantage.
b. History repeats itself
The second assumption of stock market technical analysis is that historical market movement in terms of pricing is bound to repeat. Because of this, sellers and consumers may react similarly on same market conditions. Imagine you have amassed a large volume of crops to be sold in your locale but that the demand for your fruit is low at the moment.
As a seller, since you see that there is less demand for your product during this time of year as it has been in preceding years, you will tend to market it at lower prices to produce sales. This seasonal market trend affected your decision to lower prices, but the good thing is that you still earn.
c. Intrinsic value of a business do not offer much value
Lastly, technical analysts believe that the whole is greater than the sum of its parts. Intrinsic components of businesses like financial statements or dividends are not much valued as compared to stock pricing or trade volume because the latter are entities that arose after all intrinsic factors have been considered for analysis.
Consumers may buy your fruits based on its set price and may less likely consider if yours is the freshest or the sweetest fruits or if you have the most number of loyal customers. The simple thing to remember if you really want to understand technical analysis of stocks is that stock price is the only important variable to consider in projecting sales. This is directly related to volume, past and present market stimuli and extrinsic economic factors that may come into play.
In conclusion, I believe it is your aim as a stock trader to profit from the market. To achieve this, you need to observe market trends and consumer behavior in order to create sales. As a consumer, you need to look at how buying stocks could lead to financial security or how it could pose risks.
Further determination of key variables for understanding the technical analysis of stocks can be provided by finance advisers or specialists; and if you are investing or selling involves large sums of money, then their assistance will be your best guide.
So, which is better?
Well, there has been an age-long debate among analysts as to which investment approach is better. So, there’s no convincing evidence to prove that one is better than the other; each has its own risks, as is the case with other investments.
Even though some “smart” investors try to adopt both styles in order to maximize their profit, this hybrid approach still doesn’t guarantee positive future results. Warren Buffett found success as a fundamental investor and George Soros achieved fame as a technical investor but that doesn’t meet you will find success using any of these two strategies.
So, the choice is yours to make. Consider your skill level, your style, your personality, your zeal, and your approach to financial matter. Then read books and consult mentors, experts and financial advisors for more enlightenment. This way, you will be able to choose the approach that suits you better. Finally, keep in mind that every investment carries risk, regardless of the strategy you choose and you can only reduce this risk by getting well informed before making any investment decision.