How To Pick a Stock to Invest: 5 Tips To Help the Newbies

September 27, 2001

0 min read

So, finally you decided to invest in the stock market. But Indonesian stock exchange alone is house of more than 500 companies that issue their stocks. You may get perplexed just looking at the list, let alone pick some up for your initial stock investment.

It can get challenging, but these tips may just help you pick your stocks and place your first trades.

1. Decide the Industry

You don’t have to be a stock investor to see which industries prosper in certain economic environment and which do not so much. In strong economy environment where GDP is high, manufacturing industries and technology-based companies are taking all the benefits. On contrary, non-cyclical consumer goods and financial companies are preferred.

Although this is not an exact science, but it can give you an understanding why many investors seem to avoid certain industries. Keep in mind, there are always one or two companies in the industries averted are doing better due to certain strategic decisions they make.

Don’t invest in an industry that you can’t seem to comprehend. Don’t be ashamed to admit that you don’t understand the business and you need some time to study it.

Warren Buffett, one of the titans in the investment field, once steered clear from internet companies. Then, everybody was laughing at him and thought it was because he was old and afraid to taste something new. Not long afterward, there was an internet bubble that resulted in the collapse of all internet companies stock bringing giant losses to the investors. Now Buffett is making investment in online companies as he started to understand the business rationales.

It is even better if you are used to work in certain industries and you know and strength and weaknesses of that industry. It will help you better to choose which companies to invest within the industry.

2. See Earnings Growth

You always want to invest in a growing company. Because then you will increase your money coffers. The easiest way to see whether the company is growing is to see its historical trend.

Try to map out the earnings of the company over a longer period of years. Don’t just use two to three years, because short sightedness can give you faulty ideas. Ignore the year after the company is IPO, or Initial Public Offer, the date it entered the stock market. Usually the number will be significantly higher because of the large amount of proceed and investment made.

Find out the fruitful strategies that the company is exercising to produce the growth. See in the words of the management whether they will employ the same strategies in the future and whether it is still fit given the changing situation.

3. Checkout for Debt

Debt is not always bad. As the saying goes: it is better to use someone else’s money than your own. But it can get unwanted flavor to your investment. Newbies may be wary toward highly leveraged companies. In crisis situation, having a company with huge debt is very risky because the probability it is defaulted multiplied.

To see whether debt is high or not, use Debt-to-Equity ratio. It compares the amount of debt to the amount of equity. The higher the number, the larger debt it has.

But how do you know it is high enough or not? To do that, compare it to the history of the company. If the amount of DER is significantly higher today than it was five years ago, you should find out why. It may be because of a running investment or the company is in a tight.

If the company is investing heavily, having a large debt may not be so bad as the return of the investment could payoff the debt in the future. Otherwise, you should put the company under your microscope before you invest in.

4. Invest in Stocks Sold Under Its Fair Value

Well, this should be intuitive. If you buy stocks that is already at its market value, then what kind of benefit are you expecting? But you do you know whether it is under its fair value or not.

growing stock to invest Photo by: freepik

If you can get a research report from your broker, done by a professional analyst, then it is easy. Just ponder on the recommendation and target price. Recommendations could be buy or undervalued, hold or neutral and sell or overvalued. If you don’t have the stock, then find the ‘buy’ ones; if you have, think first before you ‘hold’ or ‘sell’ it.

If there is no report on your choice stock, then use price multiples to get an idea. The most common price multiples are Price-to-Earnings Ratio (P/E or PER) and Price-to-Book Value Ratio (PBV).

PER is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). Take the trading price of the stock. Divided with basic earnings per share or net profit divided by outstanding shares. Sometimes it is readily provided in your trading apps.

PER of 10 means 10 years of earnings would match your investment. A high PER suggests that investors are expecting higher earnings growth in the future compared to companies with a lower PER. If you don’t see how the company is going to grow its earnings fast enough, don’t go for high PER companies.

PBV is calculated by dividing a company's stock price by its book value per share, which is defined as its total assets minus any liabilities then divided by its outstanding shares. Same with PER, high PBV should be avoided. PBV should not be higher than 3 unless the company is really appreciated by the market.

5. Be Careful with Low Liquidity Stock

Your company may be undervalued and great. But be careful if it does not have sufficient trading liquidity in the market. Average trading frequency and average trading volume are supposed to be high enough to make sure you can sell your stocks when you want to. To check out the liquidity, compare the trading frequency to LQ45 and Kompas100 companies. You can also divide average trading volume to outstanding shares and compare the number to best practice companies.

Hopefully these tips brave you to pick your first stocks.