Written by Colin Dodds
Published Mar 20 | 5 minute read
Stocks represent ownership in a company and give investors the opportunity for dividends and long-term capital appreciation. How thoroughly should you research a stock? That’s up to you. But the more you know about a stock and the business it represents, the more informed your decisions will be about the investment.
Researching investments is a process so crucial that it has its own name: due diligence. This means looking into the business prospects of the company whose stock you want to buy as well as how the stock has performed, the stock prices of its competitors and more.
There are many ways to go about due diligence, but here are the basics.
This part of the research can begin on the company’s website. Read through it to get a sense of what the company does or makes as well as its overarching mission. And it’s a chance to ask yourself questions about the business the company is in. Does the company’s business philosophy make sense to you? Is it a business you believe has the potential for growth?
The next step includes wading into the company’s earnings reports. Every publicly traded company is required to issue earnings reports each quarter, along with more comprehensive annual reports. The jargon and layout of these reports can take a little getting used to, so be patient. At first, you’ll have to stop and look things up. Take the time and soon you’ll be able to find the information you need easily.
The SEC requires public companies to file 10-K annual reports and 10-Q quarterly reports, which provide detailed information about financial performance and risks, according to investor.gov. However, when companies do not host full filings, these reports are available through the SEC’s EDGAR database. They will tell you how the business is doing. Is it making more money? Is it spending more money? What parts of the business are growing, and which are shrinking? These documents will also help you understand management’s perspective of those short-term financial results in light of its long-term strategy.
The biggest investments of the next decade may not even be in business yet today. The biggest investments of today may be out of business in a decade. The future is unpredictable, so how can investors make the right choice?
One way to try to predict the future is to look at what the company makes. Is it a product with a future, or is it something that people have stopped using? Think of a company that makes film for cameras. The explosion of cheap digital cameras and then the rise of camera phones have nearly destroyed that business in less than a decade. If the company provides a service, will that service likely be in demand in the future?
Another way is to look at the company’s competitors. Is it a major player with the size and scale to offer cheaper products or to buy up its competitors? How do consumers feel about the quality and value of its products compared to those of its competitors?
Most publicly traded stocks are analyzed by investment banks, who sometimes publish their analysis or who share their thoughts with journalists. Either way, there will likely be an array of opinions about the stock you’re considering. Those voices won’t always agree, so see who makes the most sense to you.
Some investors even go so far as to visit sites like Glassdoor to see how employees feel about working at a given company. Employee reviews can provide context but shouldn’t be used as a primary indicator of financial performance.
In addition to looking at the stock’s underlying business, products, competitors and what people are saying about it, look at the stock’s performance. Over time, is it going up or staying flat? Or is it highly volatile with big price swings? It’s easy to look up a stock’s long-term and short-term performance online.
Historical performance provides context, but valuation also depends on fundamentals, market conditions, and future expectations. And those observations can help you decide if it’s a wise long-term or short-term investment.
READ MORE: How To Diversify Your Portfolio: A Guide to Asset Allocation
Ask yourself how the stock fits into your overall plan for your money. Be clear what you’re investing for—a home, retirement, a child’s education or just to make as much money as possible.
Keeping that goal in mind can help you decide how long you plan to hold an investment for. Many brokerages allow you to open an investing account with $0, and even small amounts—$10 or $20—are enough to start investing in stocks, according to NerdWallet. It can also help you understand how much risk you’re willing to take. It’s also wise to check your overall investment holdings to see if you’re too heavily invested in one particular sector or industry, which can create unexpected risks.
There are thousands of stocks listed on the major U.S. exchanges. So, you may need help in selecting and researching stocks. An investment advisor may be the help you need to make important decisions, not just about the markets but also your financial plans and how to pursue them.
READ MORE: Ready for expert help? See what financial advisors can do for you.
Colin Dodds has written for preeminent media and financial companies. He is the author of several acclaimed books, including Ms. Never and Watershed. He lives in New York City with his wife and children.