Factors To Consider Before Buying A Stock
New investors often find the stock market to be a challenging place. The basic principle when buying stocks is to sell them at a price higher than what you bought them for. So, it becomes important that you are well versed with the factors you need to consider before purchasing a stock. Let’s discuss these in detail.
Check the Growth in Earnings of the Company
Have a look at the net income of the company over some time. Explore the income trends. Is the earning witnessing growth over time? It is fine even if the income growth isn’t exponential. Look for a company that has a gradual and consistent growth in income over time. Such companies will surely give you a good return on your investment. A good trading app lets you view the growth earnings in the app itself.
Look at the Balance Sheet
The balance sheet is an essential component of the fundamental analysis you perform for the company. You get an overall idea of the financial stability and strength of the firm. The balance sheet of a company provides the investor with information about the assets owned by the company, the shareholder’s equity, and the outstanding debt it owes.
When you have a detailed look at the balance sheet, you should carefully compare the debt owed by the company with the total value of assets it owns. Debts can later overburden the company, and if it becomes too much, the company might end up becoming bankrupt. The company you are investing in should have a robust financial foundation.
The cash flow statement can also be a rich source of information for an investor. It highlights the cash flowing in and out of business. Before investing, ensure that the company should have more cash coming in than going out. This is a sign of good financial strength.
Analyze the Debt-To-Equity Ratio
All businesses have some debt or the other in their balance sheet. Even the most successful companies have liabilities. But if a company has too much debt, it is a big red flag for an investor. You can compare the debt-to-equity ratio when you analyze the balance sheet of the firm. Always go for companies that have more assets and fewer liabilities.
If you are planning for a low-risk investment, only choose companies that have a debt-to-equity ratio of 0.30 or less than 0.30. If you have a higher risk appetite, you can even go for a higher ratio than 0.30. Also, a higher ratio is the norm in some industries like the construction industry. So, when investing in such companies, you can ignore the higher ratio.
Consider the Size of the Company
Your risk appetite should determine the size of the company you would like to invest in. Always compare your risk tolerance with the magnitude of the company. Publicly traded companies have some market capitalization which determines their size. The market value of the total shares of the company is also a good tool for figuring out their size.
If a stock has a market cap of less than $2 billion, it is called a penny stock and belongs to the small-cap stock category. Such companies are relatively new in business and do not have much profitability. If you want to make high-risk investments, go for this category.
The market cap of mid-cap stocks lies between $2 billion and $10 billion. These companies have tasted some sort of success which has led to their growth. They might have created a new product that has enabled profits for them.
The last category is large-cap stocks which have a value of more than $10 billion. Investing in these companies poses very little risk to the investor.
This article has been published in accordance with Socialnomics’ disclosure policy.