How to find good stocks
From companies that pay healthy dividends to ones with an undervalued share price, this is how to find good stocks.
Knowing how to find good stocks is a great skill to have right now. Equities across the board have taken a hammering recently. Unless you’ve been sleeping under a rock for the past few months, you’ll know this is largely down to a lethal cocktail: the coronavirus pandemic, and a massive crash in oil prices.
In a weird way, all of this creates an opportunity for people who know how to find good stocks to invest in. Some long-standing companies with a strong balance sheet have seen their share prices fall disproportionately, meaning there can be bargains to be had if you’re looking in the right places.
Here, we’re going to explain how to find the best-performing stocks, and which fundamentals you should be looking for. This analysis will also help you to detect companies that are in financial distress, and those that may now be overvalued after gaining popularity during the lockdown.
How to find the best stocks for investment
Before you start snapping up shares left, right and centre, it’s worth taking a moment to think about your objectives. Are you looking to make a short-term profit because you believe a share price is undervaluing a company right now, or is your goal to discover companies that are set for long-term growth and pay regular dividends?
Let’s review two important metrics that are key in learning how to find good stocks.
First up, you have your price-to-earnings ratio – the bread and butter of any investor’s arsenal. This divides a company’s share price by the earnings that have been generated per share.
For our example, let’s invent a company called GO! Industries. Their current share price is $60, and they’ve recently announced that they made a profit of $4 per share. Dividing the two means that GO! has a price-to-earnings ratio of 15.
It’s difficult to offer an exact rule of thumb that dictates when a P/E ratio is too low, or too high. One that’s too low could indicate that there aren’t big expectations for a company’s profitability in the future, but an exorbitant one suggests there is a firm belief that the company’s earnings are going to grow.
When learning how to find good stocks to trade, remember that the best points of comparison for P/E ratios can be companies that are in the same industry. If GO! had a P/E ratio of 15, but its rivals LEAVE! and STAY! had P/E ratios of 22 and 28 respectively, it could be argued that GO! isn’t performing as strongly.
These calculations should also be combined with a healthy appetite for keeping up with the latest financial news, checking over the company’s statements, and soaking up intelligence from investor presentations. As well as reflecting on what’s happened recently, this can provide an insight into how the industry is expected to perform in the coming quarter or 12 months. Analyst expectations and ratings can also be useful, but do remember that they can have a tendency to be inaccurate.
How to find stocks before they explode
This is a tricky thing to do, especially considering that old catchphrase: “It’s not about timing the market, but about time in the market.”
However, uncovering good buys isn’t impossible as long as you’ve got time, patience and an appetite for risk. After all, there is a risk you’ll make a few bad calls along the way.
One good tip is to look for stocks that are on an uptrend. This is where the stock is regularly closing the trading session on all-time high. Another crucial indicator is when the share price isn’t going as low as it was before. A good sign that an uptrend is about to occur can be a prolonged period of consolidation, meaning that a stock is constantly trading within a narrow corridor for about six months.
It’s also about staying tuned in to consumer habits. When the Covid-19 pandemic began – prompting some of us to stay at home more often – demand for video-conferencing apps and video-on-demand services began to soar. Identifying these trends early and investing in the companies that provide these services would have resulted in a tidy profit, especially if you backed stocks such as Zoom Technologies. (Of course, this strategy isn’t without its risks. You may end up betting on trends that simply don’t exist, and in some cases, you may only realise that an opportunity existed thanks to hindsight.)
How to find value stocks
Value investing has long been a strategy that’s been favoured by Warren Buffett. The premise is simple: back stocks that other investors are underestimating, the ones that are trading at a price that’s far below what they’re actually worth. In some ways, this type of trading is a philosophy. Value investors are distrustful of the herd and believe that the market is prone to taking bad news and good news out of proportion.
P/E ratio can be used to find value stocks, alongside other measurements such as price-to-book ratio. This metric focuses on totting up the value of a company’s assets and contrasting them with its stock price. Sometimes, it’s possible that a corporation with healthy financials may be undervalued on this basis.
Do remember that the best value investments aren’t always found by ploughing through endless reams of data. Look to companies that have a strong management infrastructure, and pick businesses you’re passionate about. Developing extensive background knowledge on a sector can help you uncover opportunities that other investors will miss – and detect warning signs they won’t even be aware of.
How to find stocks with dividends
This last step is likely to be more of a challenge, at least in the short-term. Because of how the coronavirus is having an impact on sales and overall profitability, many companies are choosing to cancel their dividends for this year – meaning investors won’t receive any remuneration based on their stake in the company.
Look at 0'>Shell, an oil giant that’s renowned for paying healthy dividends. It has announced plans to cut payouts by two-thirds – an unprecedented step that hasn’t been seen in 80 years. Other companies that traditionally pay dividends are also likely to face pressure to suspend these programmes, especially if they have been receiving financial aid from the government.
As you’d expect, there’s a checklist for tracking these companies down.
- They will need to have consistently high profits, and these should be rising year on year.
- The most exciting opportunities will likely be with businesses who expect healthy growth in the coming 12 months.
- Checking cashflow can help ensure that these firms have the financial means to give back to their investors.
- COVID-19 goes to show that what’s happened in the past won’t always be repeated, but in normal times, businesses with a record of increasing their dividends over several years have a better chance of continuing to do so in the future.
FURTHER READING: How to find undervalued stocks: the ultimate guide
FURTHER READING: What is a value trap? And how do you avoid it?