Things to consider before picking a stock
Main page Finance, Trading tips

So you've seen all the money to be made on the stock market and thought to yourself, "I'll have some of that".

You may have even started reading the business section of the newspaper and watched the Wolf of Wall Street. But don't rush out and start snapping up shares just yet.

Picking stocks is a risky business.

It's still a full time job for many, but the pros are vastly outnumbered by the millions of so-called "mum and dad" investors.

There is undoubtedly money to be made trading shares but like any investment where there is reward there is risk.

However, if you're willing to roll the dice then there a few things that you should consider before parting with your hard-earned cash.

Decide why you want to invest in shares

Are you out to make a quick buck?

Or do you want a stock that will provide a steady stream of dividends over a long period of time?

Perhaps you just want to diversify your portfolio?

Investors seeking a stable income tend to invest in blue chip shares or companies in sectors such as utilities.

A lower rate of growth is okay as long as the company has been consistently growing and has a proven track record of paying dividends.

Real Estate Investment Trusts are also an option.

Speculative stocks can offer higher returns but also carry greater risk.

These shares often trade on the smaller exchanges and may be very low priced.

However, cheap doesn't necessarily mean good but more on this later.

If they are small firms focussed on growth they are probably also more likely to pump any profits back into their business rather than paying dividends.

These types of shares are often best left to the pros.As the old saying goes don't put all your eggs in one basket.

You portfolio should include a number of different instruments such as shares, bonds and currency.

When it comes to shares don't put all your money in just one company or one sector.

Pick a business you understand

Stick to what you know.

The biotech company on the verge of a breakthrough may sound good but if you have no idea what it does or about the wider industry it operates in you will be hard pressed to understand how it is placed within that sector and how strong it is.

Once you find a business you understand look at the company's share price performance and results.

Annual reports, price charts, alerts and stock broker reports on the company can also help you decide whether you think the stocks is worth investing in.

Keep across the news

Start reading the business section of the newspaper religiously, in fact find out as much as you can about the companies and industries you are interested in.

Cheap does not mean good

Everyone loves a bargain but there may be a good reason why a stock is trading at 2 cents.

A share may be cheap because the company's earnings are expected to plunge while a stock may be trending higher in anticipation of future profits rather than past performance.

Try and understand the reasons a share price has gone down.

Has it been dragged down by an overall deterioration in the market while its fundamentals remain strong?

Or has it managed to tread water against the backdrop of a general downturn?

If the answer to these questions is yes, it doesn't mean you should rush out and buy the stock, but it will definitely merit further investigation.

What do the experts say?

Share trading is not like making music and copying others can be very rewarding.

Warren Buffett's investments are scrutinised all over the world, and if you had a record of picking winners over decades and making yourself one of the richest people in the world your investments would be too.

As well as looking at what stocks the Buffetts of the world are buying, investment banks and other financial institutions regularly publish which shares they think are worth buying or selling and where they predict the price will go.

Their advice should not be followed blindly but it can help inform your decision about where to invest.

Comparing companies in the same industry

Once you have identified a sector you think has the potential to make you some cash you need to find which company is the best one to help you realise that goal.

One of the ways to compare companies in the same industry is to use a few tools, which are widely available and easy to understand.

Earnings per share (EPS): Basically the portion of a company's profit allocated to each share. The higher the EPS, the more the stock is potentially worth. This could mean more money for dividends but that depends on the company's goals. All listed companies publish this information in their quarterly and annual results and it's not hard to find.

Price earnings ratios (P/E): To work out a P/E ratio, divide the current share price by the EPS. This can help you decide if a stock is over or undervalued.

As a general rule of thumb, the lower the ratio the better, however, that is not always the case. A low P/E could mean the market expects earnings to fall.

Dividend yield: You can determine the yield by dividing the dividend per share by the share price. Dividends can be a good reflection of performance but like most things when it comes to stocks, it depends. If a company is borrowing to pay dividends rather than drawing them from profits that could be problematic.

Having said all that, any investment requires a lot of research and decisions should be made based on an accumulation of supporting evidence rather than any single factor alone.

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