Conducting in-depth research into stocks and companies is essential to a profitable trading strategy. By doing your due diligence, you can develop an informed opinion about the outlooks of the companies you are trading or identify information potentially missed by the broader market. Importantly, stock research can also help you find the best stocks that align with your trading strategy and offer a prime opportunity for profit. Follow this guide to learn how to research stocks the right way.
Setting Your Investment Goals
Before learning how to research stocks, it’s important to think about what stocks you are trying to find in the context of a broader trading strategy. Are you looking for long-term investments in blue-chip companies, or swing trades centered around small-cap stocks? Knowing what type of companies you are interested in trading can help you narrow down your search.
How to Discover New Stocks
One of the most important parts of finding profitable investments is discovering new stocks to watch. These may be hot companies in a sector you’re interested in or companies that fit a specific set of criteria for your trading strategy.
There are several common methods for discovering new stocks:
Conversations with friends, families, and colleagues about the stock market can all generate new ideas for industries or individual companies to conduct deeper research into. This type of discovery can also come from buying products from a new company or seeing an advertisement for a company. While personal experience can lead to some highly profitable stocks, good stock picks from friends and family may be rare – so most traders will need to have a more rigorous discovery process.
Industry Research & Research Tools
Services include news organizations, primetime programming on financial media channels, stock newsletters, and aggregator platforms that highlight new stocks. We’ve reviewed many of these services, including Zacks, Motley Fool, Seeking Alpha, and Stansberry Research.
Financial analysts, many of whom can be followed publicly via Twitter or a blog or privately through a paid platform, can also be an extremely useful source of information for finding new investments. Many industries also offer their own newsletters or magazines, which can be useful for learning the basics about up-and-coming companies.
These stock websites do a lot of the work for you. They comb through financial statements, analyze annual reports, and study general stock market trends. They package the results as investment advice that can help you make smarter financial decisions.
Below is an example of a report from Zacks Research that combines analyst recommendations, a proprietary investment rank, and information about the companies’ earnings. Doing this stock analysis on your own would be time-consuming, so this tool adds a lot of value.
Depending on how wide a net you are casting for stocks, it may be a good idea to keep an eye on multiple different stock discovery resources.
For technical traders, stock scanners are one of the most powerful ways to discover new potential trades. Stock scanners allow you to display only stocks that fit a customized set of technical and fundamental criteria, so you can easily identify investments that are aligned with your investment strategy.
Scanners can also be useful for fundamental traders since they allow you to sort companies based on financial data. If this is how you plan to use a scanner, make sure your scanner has access to a wide variety of recent and historical financials for all companies traded on major exchanges.
How to Analyze Companies
Once your discovery process has yielded one or more potential stocks, it’s time to conduct more in-depth research. In this phase of stock research, you’ll be looking into the company underlying the stock as well as the technical strength of the stock itself. Even if you rely on a newsletter or financial service to help you collect data, it can be helpful to learn how to research stocks on your own so you can better understand the information you are seeing.
For fundamental traders, financial data is the ultimate measure of a company’s worth. Public companies are obligated to report their financial status to the Securities and Exchange Commission (SEC). Public companies submit an annual report, quarterly reports, and other filings throughout the year.
Investors can comb through the companies income statements, balance sheets, and cash flow statements to see how well the company is performing. Don’t worry – this process is less intimidating than it sounds.
While fundamental analysis is a broad topic with many nuances, one of the best places to start is to look at a company’s accounting ratios. These metrics – including gross margin, operating margin, net income, debt-to-equity ratio, quick ratio, and payout ratio – provide a quick view of a company’s profitability and financial efficiency.
Typically, these ratios provide information over the short-term, on the order of the past quarter or year. Accounting ratios can also be compared to those of other companies in the same sector to benchmark a company’s performance.
Popular accounting ratios include:
- PE Ratio (Price to earnings)
- Earnings Per Share
You can find this data in financial statements or on financial sites like Yahoo Finance.
These financial metrics can give you more information than the stock price alone. For example, the PE Ratio compares the stock’s price to the company’s earnings per share. This metric can be used to help you better understand the value of a company. While you are researching stocks, you may find two companies priced at $20 per share and learn that one has and EPS (earnings per share) of $1 and the other has an EPS of $2. While both companies have the same stock price, one company is making more money (and may be a better value investment).
The leadership of a company isn’t as easy to analyze as financial data, which takes the form of immutable numbers. However, leadership can play an important role in the future direction and profitability of a company. Be sure to closely scrutinize the executives in charge of a company of interest, including their past leadership history and results and any plans they have outlined for the future of the company.
There are many additional hard-to-quantify factors that go into determining what a company will be worth in the future. For example, whether the company has diversified revenue streams and how stable those revenue streams are can determine whether it is stable over the long term. In addition, whether the company has competitors and the nature of its competitive advantages can play a large role in the future growth and staying power of the company. Look closely at growth, and whether past or current growth rates are sustainable. Finally, consider the brand identity of the company and whether that brand resonates with the company’s target audiences.
Technical Stock Research
Technical analysis can be important for identifying potential entry and exit points into a stock. But technical analysis can also be used to take a broader view of a stock’s profit potential, such as by identifying trends. Trends can be a strong indication of whether a stock will continue moving in one direction, and you should have strong evidence from other research to bet against a trend.
Whenever analyzing a company, it’s essential to compare it to other similar companies and investment opportunities. That may mean companies in the same industry, such as direct competitors, or stocks with similar technical and fundamental characteristics. Metrics such as P/E ratio, debt-to-equity ratio, and PEG ratio can also be compared directly between stocks.
The valuation that institutional investors and venture capital firms assign to a company is a good indicator of its outlook. Not only will valuation likely be directly reflected in stock prices, but you can use valuation trajectories to look for trends in a company’s growth. Market capitalization can also be an indicator of stability – highly valued companies are generally thought to be more stable than small-cap companies. However, stability does not necessarily mean profit in the short or medium term.
How to Choose Which Stocks to Buy
Once you’ve done your research and settled on one or more stocks, there are some additional considerations that go into choosing which stocks to buy and when.
Any stock you buy should align with your overall trading strategy. That means you need to think about your investment goals – are you buying for a day trade or a long-term investment? Importantly, the timeframe over which you expect the stock to increase in price should match the timeframe of your investment.
Here are some questions to ask:
- How long do I plan to hold this stock for?
- What is my risk tolerance?
- Why did I choose this investment over alternatives?
- Do I understand the factors that impact this investment?
Technical analysis can be a valuable tool for identifying a price level at which you are willing to enter into a position. If the stock is above your set price level, you may have to wait before buying it.
In addition, technical analysis can be used to assess the strength of a stock. Ideally, you can purchase shares when a company is poised for an upward movement.
The Process of Planning a Trade
Finally, the last part of researching a stock is planning out your trade. When trading, there are several different parts of the trade to consider:
- Entry price
- Position size
- Stop loss level
- Profit target
- Trade execution and commissions
For each of these components of your trade, your research and trading strategy should suggest appropriate values. Always have a profit target in mind when entering into a trade – this is usually based on technical analysis, but can also be determined based on fundamental valuation. In addition, you should always keep a trailing stop loss to protect your position from loss and to lock in profits.
Thoroughly researching stocks before trading is essential to establishing profitable positions. From the discovery process to executing a trade, you should be looking into all of the available information about a company and integrating that information into a larger picture of how the stock price will change over the timeframe of your position. Keep in mind that comparison to other stocks in the same sector or size class, or with a similar technical setup, is also important to choosing the right stock for your strategy.