How to choose stocks?

You’ve decided to invest in stocks, but what stocks to choose and how? Read this article and you will get a step-by-step guide to choosing the right stock.

Let’s learn the basics.

To understand whether the stock has the potential to grow or not, you need to know the following terms.

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P/E Ratio

The price-to-earnings ratio (P/E ratio) is one of the most widely used tools by investors to determine stock valuations. P/E is calculated as price per share divided by earnings per share.

To find out the current price per share, you can open XM Trading account.

To get the latest earnings reports from a specific company, you can simply google “[company name] investor relations” and you’ll get the exact time of earnings release, previous reports, and the actual full report once it’s out.

The P/E ratio simply shows how much investors pay for a dollar of profit. Investors use this indicator to compare different stocks or even one stock with historical records.

A high P/E may mean that the stock price is high relative to earnings and may be overvalued. Conversely, a low P/E may indicate that the current stock price is low relative to earnings.

In general, if the P/E is high, investors can expect higher earnings growth in the future compared to companies with lower P/E.

However, a low P/E can signal that the company is undervalued and therefore has the potential to rise or that the company is doing very well relative to its past trends.

There is no strict rule for defining a P/E as low or high, but, usually, a P/E ratio below 14 means the stock price is low, and above 20 is usually considered high.

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Is low P/E better?

Most investors prefer to invest in stocks with lower P/E ratios as this means the companies have room to rise further, but also protects against the downside, as cheaper businesses tend to fall cheaper than cheaper businesses.

Of course, you don’t want to buy the cheapest company. A P/E ratio that is significantly lower than the average in the stock segment may be a negative sign.

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Dividend yield

Companies pay some percentage of the value of the shares to their investors, which are called dividends.

The dividend yield is the annual dividend payment divided by the share price.

If a company increases its dividend payout every year, it is a positive signal for investors because it shows the sustainability of its economy over a period of time.

There are several companies in the S&P 500 that have increased their dividends for the 25th year in a row.

They are referred to as dividend aristocrats. Some of them are Coca-Cola, McDonald’s, Procter & Gamble, etc.

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Types of Stocks

A growth stock is one that is expected to grow faster than any other stock, and that is why it is named so.

Sometimes, they can be riskier but traders prefer to choose them because of their potential which can become bigger in the end.

Examples are Google and Amazon. They never pay dividends because these companies prefer to use their available capital to invest in internal businesses.

Income stocks are stocks that are not volatile but have a good background in paying higher dividends than other stocks. For example, AT&T, the telecommunications giant.

Value stocks are those that are undervalued by the market.

They trade at a lower price than the price of the underlying company, according to investors/analysts.

The trick is to find it faster than other investors! When others realize the potential, the owners of those shares will benefit. Examples are General Motors and Ford.

Blue-chip stocks are stocks that have been rising for a long time and are considered low-risk investments.

However, they tend to increase more slowly than growth stocks or stocks with returns that are not as good as income stocks. Examples are Microsoft and Alibaba.

A defensive stock is the stock of companies that offer the necessary products and services so that people will buy them no matter what. They include shares of food and beverage companies as well as pharmaceutical companies. A good example is a retail giant called Walmart.

Cyclical stocks generally follow a cycle of economic growth and recession – they rise during times of economic expansion but fall during recessions and market instability.

Cyclic stocks are typically the travel and hospitality industry, automakers, and banks.

Speculative stocks are usually young companies with revolutionary technologies or unique products. The performance of these stocks is difficult to predict and is considered a high-risk investment because high returns are always accompanied by high risk.

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How to create a stock portfolio?

This is the most universal recommendation for stock investors.

Diversification is the idea of ​​not putting all your eggs in one basket – but of putting together a variety of stocks that will react differently to the same economic event.

The goal is to minimize the risk of unexpected price movements of an asset. To diversify, you need to do the following things.

• Invest in various sectors. Try to choose the one that has a sustainable competitive advantage. For example, health care stocks, auto stocks, and bank stocks would make a perfect combination. Another way to diversify is between growth and value stocks; cyclical and defensive stocks.
• Buy both undervalued stocks (which are currently undervalued in the market) and potentially higher growth stocks and decades-old giants like Amazon or Google.
• Vary companies in terms of size and type.

In the short term, the chosen stock can fluctuate, down during market shocks, but you should stick to your long-term plan, especially during high volatility markets.

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Stay up to date with market news and trends

Stay tuned for stock market news and expert opinion.

For example, electric vehicles are hype right now as Biden plans to make the US carbon-free and analysts predict a bright future for EV stocks.

However, not only Tesla, there are other stocks such as Ford and General Motors that are trying to switch from gasoline vehicles to electric-powered vehicles and are also seen as value stocks. Pay close attention to overall stock market trends and news about specific companies you own or are interested in.

This is quite a lot of information to absorb. If you read it to the end, then you are a hero! Take your time, understand all this knowledge and find your favorite stock!

Remember If you feel overwhelmed, it’s a good idea to start by investing in index funds.

Here’s how Warren Buffett advises his trustees to manage the money he will hand over to his wife: “Put 10% of cash in short-term government bonds and 90% in very low-cost S&P 500 index funds.”