How to Find Great Companies to Invest In

How to Find Great Companies to Invest In.

Smart investors put their money in reputable companies and investigate new companies thoroughly before committing their money. By carefully considering the qualities of the companies you invest in and incorporating your own knowledge of the market, you can make informed decisions in the hopes of choosing stocks of good quality and value. Be aware, however, this is no small task. Mutual fund companies and the like dedicate entire teams of experts whose full-time jobs are to research and understand how to invest in companies. Be sure you have the time and inclination to do this yourself, as well as the willingness to take the risks of doing so.

Method 1 Buying What You Know.
1. Stay within your circle of competence. If you have a field of expertise, you may be best able to identify quality within that area. Experience can provide you with the insights you need to make more informed choices. For example, if you work in retail, you may be better positioned to determine if you should invest in companies like Walmart, Target, or Best Buy, than you are in evaluating the latest bio-tech company.
Having competence in a certain area doesn't have to come from workplace experience. If you're a techie who spends his time buying and reading about the latest gadgets, you can draw on the information you obtain to help you make decisions on how to invest in the technology sector.
2. Focus on a few industries or markets. These can be either your direct area of competence or other areas that you are interested in investing in. The important thing is to realize that you can't keep track of everything going on in the global economy. Large financial institutions have whole departments for doing this so don't think you can do it on your own. Instead, narrow your focus to include only a few key industries or markets.
This doesn't mean you should avoid focusing on individual companies. You should always investigate every company you plan to invest in individually.
3. Stay up to date on news within that industry. Examples of quality sources for this are online finance websites like Bloomberg and the Wall Street Journal. They'll give you up-to-date information on many of the goings-on in various sectors of the economy and the World. Again, focus your energy on a few key areas and become knowledgeable on the happenings in them. Look for things like trends, mergers, acquisitions, relevant legislation changes, and any global events that may affect your chosen market.
4. Plan ahead. Identify a company that you think stands to benefit from some change or trend in the market. Look ahead for when this change will take place and move around your money to prepare to invest in the company. For example, if you think that a new product being released by your favorite tech company is going to be a huge success, you may choose to invest in the company before the rest of the world realizes this and drives up the stock price.

Method 2 Investing in Companies with Competitive Advantages.
1. Understand competitive advantages. There are some companies that manage to be consistently profitable and successful in their industry over many years. These companies have succeeded in building a "moat" around them to keep their competitors away. This distance from their competitors is also known as a competitive advantage. Competitive advantages allow these companies to make money and retain customers more easily than others. In turn, these companies are able to provide greater value and return to their shareholders.
An investment in one of these companies allows you to participate in their competitive advantage. While they may not grow as quickly as smaller companies, they often can be less likely to fail in economic downturns and can provide consistent growth throughout the years to come.
Blue-chip stocks are examples of large, successful companies with competitive advantages. These companies have provided consistent growth or dividends over many years and are listed on large stock indexes.
2. Invest in trusted brands. Think Harley Davidson, Coke, BMW. These are brand names etched in the public mind as the best in their class. These companies can raise their prices on the strength of their brands, resulting in deeper profits.These companies are so well-known and essential that they are unlikely to lose a significant amount of customers to competitors.
3. Find companies with high switching costs. When was the last time you switched banks? Or cell phone providers? These services retain customers because switching between them is more time-consuming than it's worth. Companies that have high switching costs can be expected to hold on to their customers longer than companies that don't.
4. Search for economies of scale. Companies that are able to make products and sell them at much lower prices than their competition automatically attract customers -- lots of them -- as long as quality is not compromised. In a crowded market, this is generally the result of economies of scale, a phenomenon where a large company is able to experience lower production costs solely due to its size. Walmart and and Dell have perfected this concept to a science.
5. Invest in legal monopolies. Some companies are granted legal (if temporary) monopolies by the government. Large pharmaceutical companies and manufacturing companies with patents are able to bring a truly unique product to market. Companies that own copyrights, drilling rights, mining rights, and other forms of protected property are often the sole producer or service provider in their area. Thus, these companies can raise prices without fear of losing customers, resulting in higher profits.
Be sure to check how long the company's patent or usage rights are in effect. Some of these are temporary and when they go, there's a chance the company's profit will go with them.
6. Look for opportunities for easy growth. Some companies are easily scalable. That is, their products or services with the potential to network or add more users over time. Adobe has become the de facto standard in publishing; Microsoft's Excel has done the same in spreadsheets. eBay is a great example of a user network. Each additional user to the network costs the company virtually nothing. The additional revenues that come in as the network expands go straight to the bottom line.
For a more current example, consider Netflix. As a streaming service, they make more money for each subscriber, even as their costs remain virtually the same. That way, as they gain more users they will continue to grow in profitability, assuming they don't choose to increase costs significantly.

Method 3 Evaluating Company Performance and Valuation.
1. Check the quality of management. How competent is the management running the company? More importantly, how focused are they toward the company, customers, investors, and employees? In this age of rampant corporate greed, it's always a great idea to research the management of any company you're thinking of investing in. Newspaper and magazine articles are good places to get this information.
This doesn't just mean that management has provided good financial results recently. Rather, look for indications of other important qualities like responsiveness, adaptability, capacity for innovation, and organizational ability.
2. Watch for management changes. A good leader can successfully turn around a company that many consider to be a lost cause. Watch the news and financial reports for changes in management positions, especially CEOs. If you believe in the new CEO of a company, based on your research, you may choose to invest in that company. Here, you're essentially putting your faith in the person, not the company.
3. Avoid overvalued stocks. Even a great company can be overvalued. Learn to interpret financial statements and pick stocks with fundamental analysis to find companies the market has overvalued. Know that these companies may be some of the most buzzed-about and invested in companies around, but they are still overvalued and may experience drastic declines in price once their day in the spotlight is over.
One way to determine if a stock is overpriced is to examine its price-earnings-ratio. The price to earnings ratio can usually be found in the company's stock summary on financial websites. Generally, PE ratios are between 20-25, but this varies by industry.
To evaluate a company's PE ratio, search online for the average PE ratio in the company's industry. If the P/E ratio is over the industry average, the company could be overpriced in view of its earnings.
4. Buy undervalued stocks. Undervalued stocks are those that are trading at a lower value than their financial information would indicate. These may be companies that have only started to do well recently. In these cases, the market has not yet caught up with their newfound success. To identify stocks with room to grow in value, you can also use the price-earnings ratio mentioned above and look for companies with low PE ratios compared to the industry average.
You can also look for companies with a price-to-book-value of less than 2. The price-to-book ratio is the price of the company divided by the total value of its assets minus its liabilities and intangible assets. A low ratio may indicate that the company is relatively cheap.

FAQ.

Question : How can I know a company's management?
Answer : A company's stock prospectus will list its management personnel. For suggestions on researching company management, go here: Investopedia.com/articles/02/062602.asp.

Tips.
Start thinking about everyday companies in terms of this new framework.
Learn the basics of reading financial statements. Check the profitability of companies you're interested in. Check their debt position. See if they have been growing steadily.
Visit the company’s website and other financial websites that will give you insight into the stock.
While it may be advantageous to invest in companies you know, do not limit yourself to just one or two sectors of the economy. Try to research companies in a variety of sectors. Doing so further diversifies your portfolio to better insulate it from a downturn in a single sector or company.

Warnings.
Be aware of stock tips: Whether they come from someone you see on TV or someone you meet in person, these are more often not well-researched or are even based on someone's grandiose theory about getting rich quick. They may also be provided by salesmen paid to inflate a stock's price to allow a company to raise as much capital as possible.
Jumping into buying stocks in a company without doing thorough research can be a quick way to lose your money.
Investing always carries risk. Even if you do everything right, there's no guarantee that you'll make money.

April 07, 2020

How to Do Technical Analysis.

How to Do Technical Analysis.

Technical analysis evolved from the stock market theories of Charles Henry Dow, founder of the Wall Street Journal and co-founder of Dow Jones and Company. The goal of technical analysis is to predict the future price of stocks, commodities, futures and other tradeable securities based on past prices and performance of those securities. Technical analysts apply the law of supply and demand to understand how the stock market and other securities exchanges work, identifying trends and profiting from them. The following steps will help you understand technical analysis and how it is applied to choosing stocks and other commodities.

Steps.
1. Understand Dow's theories behind technical analysis. Three of Dow's theories about investments form the underpinnings of technical analysis and serve to guide the technical analyst's approach to financial markets. Those theories are described below with an explanation of how technical analysts interpret them.
Market fluctuations reflect all known information. Technical analysts believe that changes in the price of a security and how well it trades in the market reflect all the available information about that security as garnered from all pertinent sources. Price listings are therefore thought of as fair value. Sudden changes in how a stock trades often precedes major news about the company that issued the stock. Technical analysts don't concern themselves with the price-to-earnings ratio, shareholder equity, return on equity or other factors that fundamental analysts consider.
Price movements can often be charted and predicted. Technical analysts acknowledge that there are periods when prices move randomly, but there are also times when they move in an identifiable trend. Once a trend is identified, it is possible to make money from it, either by buying low and selling high during an upward trend (bull market) or by selling short during a downward trend (bear market). By adjusting the length of time the market is being analyzed, it is possible to spot both short- and long-term trends.
History repeats itself. People don't change their motivations overnight; traders can be expected to react the same way to current conditions as they did in the past when those same conditions occurred. Because people react predictably, technical analysts can use their knowledge of how other traders reacted in the past to profit each time conditions repeat themselves. In this respect, technical analysis differs from "efficient market theory," which ignores the effect that human actions and reactions have on the market.
2. Look for quick results. Unlike fundamental analysis, which looks at balance sheets and other financial data over relatively long periods of time, technical analysis focuses on periods no longer than a month and sometimes as short as a few minutes. It is suited to people who seek to make money from securities by repeatedly buying and selling them rather than those who invest for the long term.
3. Read charts to spot price trends. Technical analysts look at charts and graphs of security prices to spot the general direction in which prices are headed, overlooking individual fluctuations. Trends are classified by type and duration.
Up trends, characterized by highs and lows that become progressively higher.
Down trends are seen when successive highs and lows are progressively lower.
Horizontal trends in which successive highs and lows fail to change much from previous highs and lows.
Trend lines are drawn to connect successive highs to each other and successive lows to each other. This makes spotting trends easy. Such trend lines are often called channel lines.
Trends are classified as major trends when they last longer than a year, as intermediate trends when they last at least a month but less than a year, and as near-term trends when they last less than a month. Intermediate trends are made up of near-term trends, and major trends are made up of near-term and intermediate trends, which may not go in the same direction as the larger trend they are part of. (An example of this would be a month-long downward price correction in a year-long bull market. The bull market is a major trend, while the price correction is an intermediate trend within it.)
Technical analysts use four kinds of charts. They use line charts to plot closing stock prices over a period of time, bar and candlestick charts to show the high and low prices for the trading period (and gaps between trading periods if there are any), and point and figure charts to show significant price movements over a period of time.
Technical analysts have coined certain phrases for patterns that appear on the charts they analyze. A pattern resembling a head and shoulders indicates that a trend is about to reverse itself. A pattern resembling a cup and handle indicates that an upward trend will continue after pausing for a short downward correction. A rounding bottom, or saucer bottom pattern indicates a long-term bottoming out of a downward trend before an upswing. A double top or double bottom pattern indicates two failed attempts to exceed a high or low price, which will be followed by a reversal of the trend. (Similarly, a triple top or bottom shows three failed attempts that precede a trend reversal.) Other patterns include triangles, wedges, pennants and flags.
4. Understand the concepts of support and resistance. Support refers to the lowest price a security reaches before more buyers come in and drive the price up. Resistance refers to the highest price a security reaches before owners sell their shares and cause the price to fall again. These levels are not fixed, but fluctuate. On a chart depicting channel lines, the bottom line is the support line (floor price for the security), while the top line is the resistance line (ceiling price). Support and resistance levels are used to confirm the existence of a trend and to identify when the trend reverses itself.
Because people tend to think in round numbers (10, 20, 25, 50, 100, 500, 1,000, and so on), support and resistance prices are often given in round numbers.
It is possible for stock prices to rise above resistance levels or fall below support levels. In such cases, the resistance level may become a support level for a new, higher resistance level; or the support level may become a resistance level for a new, lower support level. For this to happen, the price has to make a strong, sustained change. Such reversals may be common in the short term.
Generally, when securities are trading near a support level, technical analysts tend to avoid buying because of concern for price volatility. They may, however, buy within a few points of that level. Those who sell short use the support price as their trading point.
5. Pay attention to the volume of trades. How much buying and selling goes on indicates the validity of a trend or whether it's reversing itself. If the trading volume increases substantially even as the price rises substantially, the trend is probably valid. If the trading volume increases only slightly (or even falls) as the price goes up, the trend is probably due to reverse itself.
6. Use moving averages to filter out minor price fluctuations. A moving average is a series of calculated averages measured over successive, equal periods of time. Moving averages remove unrepresentative highs and lows, making it easier to see overall trends. Plotting prices against moving averages, or short-term averages against long-term averages, makes it easier to spot trend reversals. There are several averaging methods used.
The simple moving average (SMA) is found by adding together all the closing prices during the time period and dividing that sum by the number of prices included.
The linear weighted average takes each price and multiplies it by its position on the chart before adding the prices together and dividing by the number of prices. Thus, over a five-day period, the first price would be multiplied by 1, the second by 2, the third by 3, the fourth by 4 and the fifth by 5.
An exponential moving average (EMA) is similar to the linear moving average, except that it weighs only the most recent prices used in computing the average, making it more responsive to the latest information than a simple moving average.
7. Use indicators and oscillators to support what the price movements are telling you. Indicators are calculations that support the trend information gleaned from price movements and add another factor into your decision to buy or sell securities. (The moving averages described above are an example of an indicator.) Some indicators can have any value, while others are restricted to a particular range of values, such as 0 to 100. The latter indicators are termed oscillators.
Indicators may be either leading or lagging. Leading indicators predict price movements and are most useful during horizontal trends to signal uptrends or downtrends. Lagging indicators confirm price movements and are most useful during uptrends and downtrends.
Trend indicators include the average directional index (ADX) and the Aroon indicator. The ADX uses positive and negative directional indicators to determine how strong an uptrend or downtrend is on a scale of 0 to 100. Values below 20 indicate a weak trend and over 40 a strong one. The Aroon indicator plots the lengths of time since the highest and lowest trading prices were reached, using that data to determine the nature and strength of the trend or the onset of a new trend.
The best known volume indicator is the moving average convergence-divergence (MACD) indicator. It is the difference between two exponential moving averages, one short-term and the other long-term, as plotted against a center line that represents where the two averages equal each other. A positive MACD value shows that the short-term average is above the long-term average and the market should move upward. A negative MACD value shows that the short-term average is below the long-term average and that the market is moving downward. When the MACD is plotted on a chart, and its line crosses the centerline, it shows when the moving averages that make it up cross over. Another volume-related indicator, the on-balance volume (OBV) indicator, is the total trading volume for a given period, a positive number when the price is up and a negative number when the price is down. Unlike the MACD, the actual value of the number has less meaning than whether the number is positive or negative.
How frequently securities are being traded is tracked by both the relative strength index (RSI) and the stochastic oscillator. The RSI ranges from 0 to 100; a value over 70 suggests that the security being evaluated is being bought too frequently, while a value under 30 suggests it is being sold too frequently. RSI is normally used for 14-day periods but may be used for shorter periods, making it more volatile. The stochastic oscillator also runs from 0 to 100. It signals too frequent buying at values over 80 and too frequent selling at values under 20.

Community Q&A

Question : What is meant by selling short during a downward trend?
Answer : It means borrowing shares of stock from a broker in order to sell them at one price, then waiting for their price to drop (in the "downward trend") so you can buy them back at the lower price, thus making a profit (at which point you give the shares back to the broker). This is purely a gamble (but a popular one among some professional investors).
Question : What is meant by "buy at pullback and sell at strength"?
Answer : That's another way of saying "buy low, sell high." A "pullback" is a reversal in a rising trend, offering a brief opportunity to buy at a relatively low price. "Strength" is a high price relative to recent levels.
Question : What is meant by saying, "Buy low, sell high"?
Answer : It means you should sell shares only when they are valued at a price higher than the price at which you purchased them. In practice, it means you should buy shares only after they have recently fallen in price, and you should sell shares only after they have recently risen in price -- again assuming the selling price is higher than the original purchase price. That's not always easy to do, but that's the theoretical objective in owning stock.
Question : How can I watch how technical analysis works?
Answer : You would have to find and contact a value investor, and ask if they would let you observe them at work. A stockbroker might be able to help you find such an investor.

Tips.

While most brokerage houses are geared toward long-term investing and employ mostly fundamental analysts, many now employ a few technical analysts as well.

Warnings.
Although some technical analysts use a single indicator or oscillator to tell them whether to buy or sell, indicators are best used in conjunction with one another and with price movements and chart patterns.
Know the limitations of technical analysis: it doesn't always work. For example, the most perfect head and shoulder top pattern possible may be formed (thought to be an extremely bearish technical indicator), and you sell the stock, only to see a huge extended rally from there, leaving you behind. Do not rely exclusively on technical analysis. Use it as a guide, and combine it with fundamental analysis.

June 25, 2020