9 Ways to Tell If a Stock is Worth Buying

By Tim Lemke on 12 August 2016 0 comments

One of the most effective ways a person can build wealth over the long term is by investing in stocks.

When you own a share of stock, you own a portion of a public company. And when those companies do well, investors make money. In fact, stocks are considered essential for those looking to save for retirement or achieve other long-term financial goals.

It's possible to invest in groups of stocks through vehicles such as mutual funds or exchange traded funds. But you may also want to consider investing in shares of individual companies. There are more than 4,000 companies that are publicly traded on America's two largest stock exchanges.

But how do you know if a stock is worth investing in? What makes a stock good or bad? Here are nine things to consider.

1. Price

The first and most obvious thing to look at with a stock is the price. How much will it cost to buy a share of this company?

Now, it's important to note that prices should only be viewed in context. Many companies will "split" shares once they reach a certain level, thus reducing the price but increasing the number of shares available. Other companies never split, so a single share could go for several hundred dollars or more. But the price — especially when matched against historical prices — will determine how many shares you can purchase with the money you have. When you evaluate stocks, knowing the price of shares and their history will help you determine if you're getting a good value when buying.

2. Revenue Growth

Share prices generally only go up if a company is growing. And one of the few ways a company can grow is by increasing its revenue. Revenue is often referred to as the "top line," and it's a major indicator of whether a company has been successful. It's important to not look at revenue in a vacuum. Instead, look at the increase or decrease in revenue from one quarter to the next and one year to the next. A positive trendline bodes well for the stock price, but if revenue is flat or declining, it's important to find out why before investing.

3. Earnings Per Share

How much money does the company have leftover at the end of each quarter? Take that figure, divide it by the number of shares it has sold, and you get the earnings per share number, or EPS. For example, if a company made $40 million in profits last year and has 24 million shares, the EPS is $1.66.

EPS can be a driver of stock prices, as investors generally don't want to overpay for a stock. Generally, the higher the EPS, the better shape the company is in. But there is often debate about the best range for EPS, and companies can manipulate it by buying back shares, thus boosting EPS without actually increasing profits.

4. Dividend and Dividend Yield

Many companies will return a portion of their earnings to shareholders. Investors can get a small payment for every share they own, known as a dividend. Many healthy companies will issue good dividends each quarter and the revenue from this may outpace the interest you would get from a normal bank account. Thus, dividend stocks are popular among investors looking for additional income, as well as share growth.

It's easy to search for companies with the highest dividends, and you can also search for dividend yield, which is the dividend divided by the share price. If a company has maintained or raised its dividend, that's a sign that it's on strong footing. A cut to dividends is often a bad sign.

Some of the most well-regarded public companies have been designated as "Dividend Aristocrats" for distributing and increasing their dividend for at least 25 consecutive years.

It's worth noting that many good companies do not distribute dividends because they prefer to invest the cash back into the business. (Amazon is one high-profile example.) And many companies, such as utilities, offer dividends because they can't offer great growth in share value.

5. Market Capitalization

Bigger is not always best, but if you are looking to invest in a stock that will give you steady growth without a lot of volatility, the largest companies are often your best bet. A company's market cap is essentially the value of all its shares. Companies with large market caps are often large and diversified enough to avoid being affected by a single piece of bad news. Think of behemoths like Procter & Gamble, Coca-Cola, or ExxonMobil — good, solid companies that have offered decades of solid returns.

6. Historical Prices

All companies go through rough patches. But if you are investing for the long term, you need to do more than look at a single company earnings report or current price performance. Looking at five-year, 10-year, and even 15-year returns will give you a sense of whether a company can withstand tough stretches. Historical returns are not a guarantee of future performance, but can at minimum be illustrative.

7. Analyst Reports

Many brokerages and investment banks have a staff of research analysts that issue reports and recommendations about individual stocks. Often, these reports come with "buy" or "sell" ratings, based on the analysts' judgment of a company's share price and finances. It's important to note that analysts often disagree, so it's best not to rely on a single report before choosing whether to invest.

8. The Industry

It's usually important to examine not just a stock, but the industry that the company operates in. By doing this, you may get an understanding of whether a certain type of business or sector is struggling or doing well. For instance, when evaluating a company such as McDonald's, you'll want to look at the entire fast food and restaurant sector to gain an understanding of how Americans are eating out. Looking at a stock in this context will help you understand if there are positive or negative influences that may not be immediately reflected on a company's share price or balance sheet.

9. Major Economic Indicators

No matter how hard it tries, a company can't control every single thing that might impact business. The broader economy of the nation and the world can play an outsized role in the health of a company and its share performance. Things like consumer prices, the unemployment rate, or changes to interest rates can impact how a company is doing independent of its own business. While the stock market and economy are two separate things, they are very much linked. For the most part, when the economy is doing well, companies are doing well and share growth comes with that. Likewise, share prices can lag during slow economic times or times of economic uncertainty.

Anything we've overlooked? What do you look at when you evaluate a stock?

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Guest's picture
Lynne

I totally agree with your post. I am gonna share this to my friends who wants to become investors themselves.