The ultimate question all investors ask is whether a particular investment is actually worth it. Experienced and knowledgeable investors have the ability to run complex financial and statistical analyses to determine exactly this. Newbie investors may not have access to such complicated tools. There are several reasonable and largely bias-free ways to determine whether you should be investing in a particular security, whether an investment is a dud, or whether it has the potential to pan out and make you rich.
Assess the Financial Health of the Company
Knowing how to invest in stocks is half the battle. Stock analysis largely depends on the overall finances of the company. Even if the product looks promising, the company must be able to financially carry out obligations to investors. Generally speaking, if you see the history of a company worth that is gradually dipping low, then you might not want to invest in those shares. Checking the financial health of a company can be quite tricky. For example, if you are interested in penny stocks, the company behind the stocks might be a brand new startup without a financial history to look at. In that case, you will have to assess the product and the management system. You can run a basic financial assessment by reading annual reports for the company and looking up company and stock values going back a decade if the company is that old. Don’t forget to look up prior reports that may be filed with the SEC.
Read Financial Reports
Don’t rely too much on self-reported financial data offered by companies. Some data can’t be manipulated easily, such as earnings and cash flow that are legally-bound to be reported to the SEC. The SEC’s EDGAR database makes financial disclosures from businesses available to investors. Look at these financial filings when considering an investment. If no report is filed, then the company is either new or might be performing poorly.
Meet the Management
This is an important step to take with startups. If you are hoping to invest in a promising new company, meet the management and read financial reports. No matter how promising a company might seem, incapable managers and founders could derail the whole enterprise. If possible, interview the founders and CEO to determine if they are actually competent enough to develop the product and introduce it to the market. A great idea doesn’t generate money on its own; the most successful companies become what they are thanks to excellent management teams.
Mind the Price to Earnings Ratio
The P/E ratio is a metric for valuing stocks. This ratio is gleaned by dividing earnings per share. This ratio gives investors a good idea of whether a company is lucrative and has a viable product that is in demand. The P/E ratio for companies can be easily found online or in business newspapers. You can determine whether this ratio is good or bad by comparing it to the median P/E ratio of stock index you are working with. For example, S&P has a median P/E ratio of roughly 15. A stock valued over this price is considered overpriced while a stock under the ratio is an underperformer.