Whenever the word “stock” is mentioned at social meet ups, you can clearly see two kinds of people – people who invest and everyone else. We like to believe that “everyone else” is also interested in investing in stocks, but may have certain fears that prevent them from doing so.
Some of these fears are not unfounded. People need to have peace of mind that their money is safe, and the only way to understand that their money is safe is to accumulate knowledge about investing.
We understand not everyone has so much time on their hands to become investment experts overnight. So here are 5 things to consider before you get started and buy a stock.
ALSO READ: 5 Money Fears That Can Be Easily Conquered
(1) Understanding Who They Are
Investing doesn’t just mean you pick a stock, put money into it and sit back and collect returns. Buying a stock means you’re investing in a real business, and you have to understand the products this company is selling to its customers, the outlook of the industry in the long-term, the competition it faces and how the management runs the company.
Think of it as hiring someone to make money for you. You wouldn’t just hire the first person you meet, or so we hope. Instead, you’ll understand what that person is capable of, what are his or her plans, and whether the hire makes sense.
(2) How Expensive It Is
There are several indicators to measure how expensive a stock is. What you’re basically trying to find out is whether it is worth your money to buy the stock at the price it is currently at. We do that all the time in our lives, comparing whether a product or service is worth our money. Buying a stock is no different.
One way to measure this is to use the Profit-to-Earning (P/E) ratio. The PE ratio represents the price you have to pay for every dollar the company is earning. The higher the number, the more you’re willing to pay for every dollar of earnings. You have to then ask yourself why you’re willing to pay such a high price for every dollar of earnings.
One reason could be that it is a very stable and safe stock. Another reason could be that there is a very strong growth story for the future of the company. Either ways, you should know why you’re paying such a high or low price for the stock.
Do note there are other ways to measure how expensive a stock is. One other way would be the Price-to-Book (P/B) ratio, where you understand the price you’re paying for the intrinsic value of a stock, or what it is essentially worth if it sold all its assets
(3) Returns/ Dividends
Returns are an important aspect of stocks that people have to understand before buying. It is not unheard of for blue-chip stocks to offer upwards of 4% returns and REITs to offer over 7% returns.
There are also instances where returns are over 20% for high growth companies that do not give out any dividends. In this case, share prices of these companies soar as its business expands and delivers high growth in revenue and profitability.
At this point you also have to note there have been many incidents where companies paying out great dividends ended up going bust or saw terrible performances in subsequent years, as it experienced a slowdown in its industry.
Liquidity is another very crucial aspect of stock investing for retail and beginner investors. Liquidity represents how quickly you can turn your stock into cash. Some small and less well-known companies that offer high returns do not allow you to instantly sell your stocks for the market price. This happens when there are not enough people trading the stock in general.
This is extremely important to consider when purchasing stocks as beginner investors may decide to get out of wrong trades or want to liquidate their stocks into cash for personal reasons in life.
(5) Your Individual Investing Profile
When you’re deciding to buy stocks, you must consider your own investing and risk profile. Are you able to swallow huge losses in the pursuit of high returns? Are you seeking safe companies with stable performances in the long-term? These are questions you need to ask yourself before buying stocks.
The second question you need to ask is whether this stock aids in diversifying your holdings. Diversifying through industry will help reduce your portfolio volatility when a specific industry is facing a tough time.
Read Also: Should You Still Be Buying Stocks In 2016.