How to Read Stocks - Tips for Better Investments
Interested in buying stocks?
Owning individual stocks is a step toward becoming a more active investor. This step isn't for everyone; but for those curious about the stock market, it can become a lifelong interest - and maybe even a way to make a little extra money.
Learning to read a stock chart and research potential buys is like learning a language. A little knowledge can be enough to get started; but if you want to become fluent, you should be prepared to keep learning.
This article covers some of the basics of starting to pick individual stocks.
As you start on this journey, keep in mind that not every investment you make will pay off, but each one should be an opportunity to learn and get better at it.
Stock-Picking: DIY or Use a Professional?
Many people own stocks through mutual funds, but picking individual stocks is a whole other level of investing.
Mutual funds typically own large numbers of stocks. The benefit this provides is diversification, meaning that no one stock will have too big an impact on your overall return.
When you pick individual stocks, you are ratcheting up both the potential risk and the potential reward. This means some intensive study should go into any individual stock you own.
The basic question you should ask yourself about owning individual stocks is whether you want to pick them yourself or have a professional do it for you.
A professional financial advisor is likely to have more experience and resources than most individuals when it comes to picking stocks.
On the other hand, if you have specialized knowledge or business experience that you feel gives you unique insights into certain companies, you may want to make some picks yourself.
Even if you decide to have a professional pick your investments for you, knowing some of the basic language and principles of stock-picking can help you ask the right questions and better understand what that professional is doing on your behalf.
How to Read a Stock Chart
A variety of finance websites produce stock charts like the one shown below.
At first glance, this may look confusing; but when you break it down into its individual parts, you'll start to see it holds some of the basic information you'll want when considering a stock.
What you see here is a chart for Apple Inc. Some of the highlights you should look for in a chart like this are:
Near the top of the chart is the company name followed by the symbol "AAPL." That is called a ticker symbol, and these play a very important role whenever you buy or sell stocks.
Sometimes different companies can have similar names. To avoid confusion when trading, each stock is assigned a unique ticker symbol. You should use this symbol when trading to specify the exact stock you want to buy or sell.
Ticker symbols can be a variety of lengths, but most are from 1 to 4 letters long. Always look up the precise ticker symbol for the stock you want to buy.
The share price of a stock may be reported in a variety of ways, including the previous day's closing price, the present day's opening price and the current price based on the most recent trade.
Since prices can move rapidly, the most important price to look at when you are about to trade is the current price. In this chart, the closing share price on May 22, 2020, wad $318.89.
Earnings per share (EPS)
Earnings are the official profit made by a company. The total earnings of the company are divided by the number of shares to report the amount of earnings each share represents, or earnings-per-share (EPS).
EPS is generally reported on a trailing twelve months basis - that is, for the most recent year. The trailing twelve months period is represented by the abbreviation "TTM." On May 22, 2020, the EPS for this stock was $12.73.
Price-to-earnings (PE) Ratio
Another common statistic you'll find on a stock chart is the price-to-earnings or PE ratio.
This is the current price of the stock divided by annual earnings. The EPS for AAPL stock in this chart is 25.05. The significance of the PE ratio will be discussed in a later section of this article on price vs. value.
Line chart of price history
Stock charts are often dominated by a line chart showing the price history of the stock.
This helps create some perspective on where the stock is trading now compared to where its price has been previously.
It's important to select the right period when looking at price history. A short period like a day or a week might exaggerate short-term price fluctuations. On the other hand, a very long history like 10 years might include distant history that is no longer all that relevant.
Bar chart of number of shares traded (daily volume) history
Along the bottom line of a price history chart you will often see a series of bars. This bar chart shows the daily trading volume of the stock.
Trading volume can put price changes into perspective - the heavier the volume, the more market conviction there is behind any price move. Also, looking at recent volume can show if a very thinly traded stock may be subject to a large price move if volume picks up.
Assessing Price vs. Value
On its own, the price of a stock doesn't tell you much beyond what you would pay to buy the stock now. The true value of the stock has to be judged by putting the price in perspective with some of the underlying financial characteristics of the company.
Price-to-earnings ratio is an example of this. It shows how much you would have to pay for every dollar the company makes.
According to www.macrotrends.net, the PE ratio of the S&P 500 has averaged 17.21 historically. That means you typically would pay over $17 for every $1 of a company's earnings.
This indicates that stock investors often have a very long-term outlook - enough so that they are willing to pay for many years of earnings up front.
A high PE ratio can also be an indication that investors expect earnings to grow quickly. While PE ratios are typically measured on a backward-looking (i.e., trailing twelve months) basis, investors are often hoping that earnings will be significantly higher in the near future. This growth would make the price more reasonable relative to future earnings.
PE ratio is not the only measure of a stock's value. Price-to-sales ratio and price-to-book value are other common examples. The better you know a company, the easier it will be to determine which valuation measure is most relevant to how that company does business.
Getting to Know a Company: News vs. Hype
How do you get to know a company?
It is important to separate hard news from hype. Investment websites and TV programs are full of people trying to hype stocks - often because they own the stock themselves.
To look beyond the hype, follow the periodic announcements a company makes about its progress. Companies will often try to put a spin on their results, but a good way to judge a company's progress is by how well they've succeeded in meeting the sales, earnings and other goals they set out in previous announcements.
Creating a Wish List
More often than not, the market more than fully recognizes the value of great companies. In other words, it's hard to buy an industry leader at a discount that would allow you to make a good return going forward.
However, even if the prices of your ideal stocks are too high at the moment, you can put together a wish list of what you would like to buy if they came down to the right price.
That way, when a negative event like a market correction hits, you will be ready to scoop up good companies at bargain prices. Meanwhile, maintaining that wish list allows you to follow the companies on that list for a while and get to know them better before you buy.
Being Mindful of Trading Costs
When you start buying stocks, be aware that trading costs will cut into any return you earn. These costs include trading commissions plus what's known as the trading spread.
The spread is the difference between what sellers are asking for a stock and what buyers are willing to bid for it. In a strong market, stocks will trade closer to the asking price; in a weak market, the opposite is true.
Trading costs will hit you twice - when you buy and when you sell. These are known as the "round trip" costs of trading.
One way to reduce trading costs is to find an online broker with competitive commission rates. These days, those rates can be as low as $0 per trade.
Setting Sell Triggers
Finally, when you buy a stock, you should decide under what circumstances you would sell it.
Your sell trigger might be a specific price target, but you should also consider certain other goals or events. For example, if a company starts failing to meet their sales goals, it may be a sign that their business model is not working as planned.
All of this is a lot to digest. That's why many people choose to have a professional do their investing for them.
If you decide to do it yourself, the best advice is to start small. That way you can learn without having too much money at stake.