How to pick a stock

A basic knowledge of how to invest in the stock market is an important financial skill. Yet many find penetrating the mysteries of Wall Street to be a rather daunting task. After the market turmoil of the past couple of years, people are understandably hesitant to risk their savings. It is more secure, however, for college students to invest in stocks than older people. Because students in their late teens and early 20s have a longer time horizon to recoup any losses, they can take more risks in growing companies and are not just confined to steady dividend-paying blue-chip stocks or fixed income bonds. Blue chip, which borrows its name from the highest-value poker chip, is a term that describes the stocks of well-known and established companies with a record of steady earnings such as Exxon Mobil, AT&T or Microsoft.

In addition, the earlier you start investing, the more money you will accumulate from both growth and dividends. That being said, you should only invest with discretionary funds that you would be relatively OK with losing. You should not use your basic savings or the money you are setting aside for your next Spring Break trip to Cancun. Fortunately, investing is now much easier and cheaper to undertake than it was in the past because of Internet brokerage sites such as thinkorswim or E-Trade that allow you to buy and sell stocks online for low commissions.

The first challenge is to try to choose which companies to invest in. An easy way to generate some ideas is to think about companies you are familiar with. For example, if you like products from Ford, Nike or Chipotle, chances are others like those products, too. Investing should be enjoyable, and by investing in familiar companies, you will be more engaged and involved, especially if your stock picks go up.

After you figure out which company interests you, it is critically important to know what the business does and how it makes money before you invest in it. A good test for this is if you can explain the chosen company’s business model to a 10-year-old. If you can teach how a business works, then you know its business model, as well. If the business model is confusing or overly complicated, leave it to the experts.

Next, see if the company you like is in an industry with high barriers to entry, called a ‘moat’ in the investing world. Ask yourself, “If I wanted to, could I go into business in this field?” Some businesses, such as commercial aircraft manufacturing, are very hard to set up. You would have to raise enormous amounts of capital and hire hundreds of mechanics, engineers and other specialists to start an aviation company. Other types of businesses, like fast-food chains, are relatively easy to set up. Although there certainly are good investing opportunities in industries with lots of competition, it helps to have high barriers to entry.

In addition, look for companies with a stable management team and healthy finances. To find this information, you will need to go to a website like Yahoo or Google Finance and enter the company’s ticker symbol. Then find the income statement, which is found under the ‘Financials’ icon. Click on the income statement and look at the company’s net income, which is found at the bottom of the income statement. Numbers in parenthesis on Yahoo Finance or in red on Google Finance mean the company has lost money, while numbers in black indicate the company has made a profit. Notice the trend in these numbers for the past couple of quarters and years. Even if the company has lost money in a certain year or quarter, this might be explainable and not necessarily make the company a bad investment. Also take a look at the company’s management. Has the CEO been with the firm for 20 years, or has the company hired and fired three CEOs during the past five years?

Finally, just like you have to study for your classes to do well in them, you must do a little homework in the financial markets. Forbes.com has good, free articles about the economy and stocks. The Wall Street Journal is a good source, too, especially in the Money and Investing section. Investor’s Business Daily also is useful and many financial blogs offer helpful investment advice. There are many other resources at your disposal beyond the media. If your parents have a brokerage account with a firm, ask them to request a company analysis report from their stockbroker. Additionally, if you go the company’s website, there should be a tab that says “Investors” or “Investor Relations.” Find the contact number for “Investor Relations” — a person in the company who you can call and ask whatever questions you may have.

Overall, profitable companies with good business models, high barriers to entry and steady leadership are compelling investing ideas. Just like any skill, investing takes practice and the sooner you start — and you should start gradually — the better off you will be in the long run. Obviously there is much more to investing than what is outlined in this article, but a grasp of these simple concepts can make you a better investor.

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