Investing in and buying stocks has become almost commonplace. With the advent of online discount brokerage firms like Scottrade and TradeKing, you can open a brokerage account and purchase a portfolio of individual stocks with the haphazard click of a mouse (and have 10 minutes to spare).
But stock investing requires diligent research, a patient and long-term demeanor, and the ability to check your emotions at the door to be truly successful. In stock investing, it is essential that the individual investor comes up with a strategy, a set of criteria for risk management, and a mindset that will work in any market condition (i.e. secular bear market) and any economic or political climate.
There are as many stock investing strategies as there are stock investors in the world. Possibly the most important single factor in long term success, despite your chosen investment strategy, is the ability to remain calm, analytical and stick to your long-term plan, regardless of what’s going on in the world around you.
Without knowing your individual stock investing strategy, it is impossible to create a perfect stock investing checklist that’s comprehensive for everyone to use. But what I’ve come up with here is more of a framework to ensure that you are not making some of the most egregious investing errors.
Feel free to bookmark this page for easy access or print it out and hang up on your wall. You’ll want to refer back to this before you purchase any shares of common stock.
Stock Investing Checklist – 8 Step Guide
Step 1: Ask yourself what brought this stock to your attention.
Fortunes have been squandered by acting on whispered stock tips during a dinner party or recommendations from a stock broker. Possibly the biggest red flag for any stock investor are the words “buy this stock immediately.” It doesn’t matter if the source of the stock tip is the Oracle of Omaha himself (i.e. Warren Buffet), if you invest based solely on stock tips, you are not being an educated and diligent investor.
Step 2: Make sure you understand the company and business model.
If you don’t know how the company earns its profits, you are in no position to evaluate the future long-term performance of the business. If you think a company may be a good investment, but don’t yet understand the way it earns its money, do some research. You may find the company to be an excellent long-term investment, or you may determine that the stock is overvalued and speculative, and not worth your hard earned dollars.
Step 3: Know the numbers.
It is essential that stock investors be aware of the basic financial performance of a company they are investing in. Even pure technical investors, who analyze stock charts for historical patterns, should understand the historical P/E (Price-Earnings) ratio of stocks in the company’s sector, how the P/E can be offset by the valuation of the company’s growth, what the company is inherently worth (its liquidation value or book value), as well as its debt load, return on equity, and how much the company is earning per share. These numbers are confusing at first, but with diligent practice, reading a balance sheet becomes second nature, and can save you from risky and speculative investments.
Step 4: Look to the company’s competitors.
Often times, a company comes to your attention because it is part of a lucrative sector of the economy. Perhaps this company is an excellent investment, but on the other hand, maybe its main competitor has better long-term prospects, a faster growth rate, or a superior management team. We recommend looking to at least the other 2 top competitors in the industry and comparing apples to apples to determine the superior investment.
Step 5: Determine what the company is worth to you.
In order to invest in a company, you must determine what you are willing to pay for the shares of stock. Sometimes you will wait until the stock undergoes a market correction and purchase at a discount. Other times, you will find that the stock price is already discounted, and there is no better time to invest than the present. Keep in mind though, you cannot time the market. You can only determine a fair price for the company’s shares based on what you believe the long-term value to be.
Step 6: Diversify.
In a perfect world, your portfolio will be divided equally between sectors and regions represented by your individual stocks (i.e. stock investment diversification). By doing this, you will protect yourself should any kind of catastrophe take place within a specific sector or region. Diversification also requires you to have you money invested in multiple companies, rather than having all your eggs in one basket. At the same time, we recommend that the individual investor should only own shares in as many companies as they are capable of actively tracking and monitoring. In this regard, buy and hold passive investing isn’t the greatest strategy if you are not keeping an eye on the stocks. The buy and hold mentality can only be successful if you are keeping an eye on the underlying company so that you will not be caught off guard by a falling share price without understanding the catalyst. To give you an idea of how many stocks should be in your portfolio, most individual investors are able to track 5-10 stocks in their individual portfolio.
Step 7: Track your overall performance.
In a diversified portfolio, it is important to understand that you will never pick all winners. Sometimes stock prices will fall, despite the company’s long-term prospects. The most important thing to track is your overall performance vs a market index such as the Dow Jones Industrial Average.
Step 8: Know when to sell.
Panic selling has cost many investors a great deal of money. Investing is a long-term commitment to your future financial goals and well being. In order to know a good time to sell stocks, you need to understand the tax implications of stock sales, as well as the potential reasons to sell a stock. Keep in mind that sometimes, when the facts change, you should sell a loser. This will result in tax savings, as well as making a conservative decision based on your initial investing strategy. In addition, sometimes you will determine to add to your position despite the stock’s meteoric rise, because its long-term prospects are that much better. Just stick to your plan and don’t let emotion get the best of you.
Do you think this is a thorough list of things to know and understand before you start investing? What additional tips would you give to first time investors? Please share in the comments below.
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