Financial news can be pretty intimidating for the uninitiated. With jargon like “short squeeze,” “EBITDA,” and “support levels” thrown around, it’s easy to want to roll your eyes at a typical stock market article or news segment. We writers tend to ignore the basics, often pinpointing only specific aspects of an investment, but for beginning investors, making smart stock picks isn’t as difficult as it seems. Your financial advisor may want you to think otherwise, showing off his or her mastery of the lingo along the way, but most of that knowledge is just fluff.
What you actually need to know to invest is pretty simple. Here are the five basic things you should look at before pumping your hard-earned cash into the market.
The numbers may look overwhelming, but investing’s not rocket science. Source: Jeremy Bowman.
Before even looking at the numbers, take the time to assess the company’s business model and long-term prospects. Warren Buffett once advised acolytes to invest in companies, not stocks. This part of your analysis will be purely qualitative. Ideally, you should be able to make an argument without using any numbers. Look for companies that are ahead of the curve on evolving trends and have some sort of competitive advantage, blockbuster growth prospects, or simply a great product. Think of the proverbial economic moat — brand strength or intangible assets that create barriers to entry. Google in search is a great example of a company with a strong moat.
Two of this year’s best-performing stocks have been “story” stocks. Tesla Motors Inc (NASDAQ:TSLA) and Netflix, Inc. (NASDAQ:NFLX) have both delivered multibagging returns, mainly on the promise that they could redefine their industries –Tesla Motors Inc (NASDAQ:TSLA) in automobiles, and Netflix, Inc. (NASDAQ:NFLX) in cable and home entertainment. The companies are barely profitable, but they are at the forefront of potential industry revolutions, and investors are willing to ignore their sky-high valuation because of it. They are quintessential disruptive innovations. Like Apple Inc. (NASDAQ:AAPL) 10 years ago — whose iPod, iPhone, and iPad led the stock up 100 times in just a decade — these companies have the rare potential to do the same for investors who got in at the right time.
Of all the numbers you look at as an investor, a company’s growth rate may be the most important. After all, you’re looking for your investment to appreciate in value, and it can’t do that if sales and profits don’t increase. When looking at growth rates, don’t just consider short-term percentages; think about long-term opportunity. Generally speaking, high growth rates tend to slow over time, sometimes more abruptly than expected. For example, Apple Inc. (NASDAQ:AAPL) until recently was seeing growth rates above 40% for several quarters, but the smartphone and tablet markets matured, and the company found it difficult to top its already monstrous profits.
For a company with long-term growth prospects, Chipotle Mexican Grill provides a good example. The burrito roller is a truly beloved brand, but it has only about 1,500 restaurants worldwide. Compare that with McDonald’s, with more than 30,000 stores, and Starbucks with nearly 20,000 locations globally, and it’s easy to see how Chipotle could still have considerable room to grow a generation from now.
But you can’t consider a stock’s growth rate without factoring in the price, which brings me to my next point.