5 things to know before investing in stocks

Investing in stocks can earn extra income through dividends and capital gains. Conversely, doing it without knowledge and practice can lead to losses. What factors to consider when buying stocks in India or any other country? This guide will let you know how to choose what shares to buy. Let’s dive right in.

What do stocks?

There are certain factors to consider before investing in a company. Let’s have a glance at them, letting you know how to check the stock market for maximum results.

What to look for before investing in stocks:

• Work in a sector that you know. Every company serves a specific industry. To become a top-notch investor and trader, you must adhere to the industries you know about. Ideally, the sector you understand best should be the one you trade in the long run.
• Make sure the company is stable. Before investing in the company’s stock, you must review the audit report and financial statements. If the auditors have highlighted a certain point in their report, follow up on these points in notes to the financial statements. In this way, you can enlist yourself among pro investors and differentiate from the newbies.
• Learn all about paying dividends. Another important point is determining whether or not that company pays dividends on its earnings. Expert investors only invest their hard-earned funds in companies that pay dividends. You can also trace this fact to the declaration of dividends from financial statements.

Note! To stay ahead of other investors and traders, you can set up Google Alerts for your desired company’s stock to get the latest information.

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Price-to-Earnings (P/E) Ratio

The P/E ratio is a parameter by which the value of a company is measured. It reflects the tendency of how much an investor has to pay to make earnings of $1.

Calculation formula: P/E = Stock Price Per Share / Earnings Per Share

Pro investors and traders should know this ratio to learn how to decide what stocks to buy. You can determine the P/E ratios of multiple companies under a particular industry and choose which one to invest in.

Note! For better results, ensure to calculate the P/E ratio of a company for the past five years to precisely know what kind of trends it is riding. It will also help you learn how to check stock market trends.

If a company has a P/E ratio of 10, it means that the investors are willing to pay $10 to cash earnings of $1, which accounts for a 10% return on your investment.

Beta mechanism

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The stock market continuously moves up and down, and because of that, there was a need to develop a concept that could measure the volatility of a stock as compared to the market as a whole. So, the investors devised a mechanism called “Beta,” which measures a stock’s volatility compared to the whole stock market during the last five years.

Beta is used to measure the systemic risk involved in a company’s stock in contrast to the entire stock market (typically S&P 500). To understand the centric idea behind Beta, you must also know what S&P 500 is. 

Here’s an easy-to-grasp definition:

The Standard & Poor’s 500 index (S&P 500) is a collection of 500 well-known publicly traded companies in the United States. This name was given considering the return on investment (ROI) percentage of the best groups of stocks. Such stocks yielded an ROI of 10 percent annually over a long period.

Whenever experts compare a stock’s Beta with the market, they typically compare it with these popular companies under S&P 500 index.

The market as a whole has a Beta number of 1, and every other stock is defined in relation to this number. Here’s how the system works:

• Stocks with a Beta higher than 1 are more volatile than the whole market, which means that if the market goes up, such stocks will go even further than the market itself. The same goes for when the market goes down.
• Stocks with a Beta lower than 1 are not much volatile as compared to the market. These stocks pretty much follow the same pattern as the market does. So if the market goes up, they will follow a similar trend, and the same goes for the opposite direction.

Stocks with a negative Beta can also appear, but this is not a usual phenomenon. But, if this occurs, the stock will follow an opposite pattern compared to the market, meaning if the market goes up, such stocks will go down, and vice versa.

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Dividends

A dividend is the earnings you make as a shareholder by investing in a company’s stock. It is paid to all of the shareholders of a company from its net profit in relevance to the number of shares occupied by a shareholder.

If you are looking to merely park your extra funds into the stock market to earn passive income, investing in a company that pays dividends can be the perfect strategy. Once you invest in a company that issues dividends on its earnings, you will be paid regardless of the stock price. 

Do not dump all your cash into a single company in the hope of earning dividends. You need to devise a proper strategy to invest in sectors that pay a handsome return on investment. Some reputed sectors with dividend-paying companies are oil and gas, basic materials, healthcare, pharmaceuticals, banks, and utilities. 

Before you go out to purchase stock shares, look for the company’s dividend rate.  Further, make sure to invest in companies that pay dividends regularly. The normal cycle of issuing dividends for reputed companies is three months, meaning quarterly issuance of dividends. Most of the time, these companies issue a cash dividend, but sometimes they can also be an increase in the number of shares investors hold. 

Random walk theory

The key is to invest in a company that pays dividends consistently. You should look out for the past dividend-issuing trends of this organization by checking the movements of the preceding five years. It is the best long-term strategy to get additional income.

The chart

Investing can be tempting, but you must perform your proper research before deciding to buy a stock. A pro-investor is always a top-notch analyst as well. Reading charts is a skill you must acquire if you aspire to become a professional investor and trader.

To make a sure-shot investment, you must understand different stock charts. These include line, bar, and candlestick charts. Stock analysts use these charts to understand a stock’s movement and make more accurate investment decisions.

You can follow a golden rule of thumb when analyzing the charts, i.e., if the charts start at the lower left and end at the upper right, that’s a good sign to invest in a stock. Conversely, if the chart follows a downward direction, you must stay away from that stock.

The Bottom line

So we’ve finished discussing the essential things to know before investing in stocks. These rules are vital when forming an investment strategy and what shares to look out for.

However, you must be aware of the risk of losing your capital. Before investing in the shares of any company, get trained and test your first forecasts by trading on paper.