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What Should I Consider When Buying Stocks?

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  • Written By: KD Morgan
  • Edited By: Bronwyn Harris
  • Last Modified Date: 06 November 2016
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Buying stocks is a means of investing in companies in which you want to own equity. These ownership positions are issued in instruments called stocks. People purchase stocks through stockbrokers, agents, the company itself or they can be traded individually.

It is important to consider not only the company you want to invest in, but also the environment of the stock market at the time. For example, if the market were in a long-term downturn, or recession, you would want to investigate companies that produce necessities of life. Certain household items, or consumer goods, are more dependable options during this time. They will always be needed, regardless of the economic environment.

On the other hand, if the markets are rising and positive, growth stocks might be a consideration. This is a time when people are interested in expanding their horizons with new technologies and ideas. Consequently, these higher-risk stocks will do better when the market averages are going up.

An important indicator for the stock market is the gross domestic product (GDP). This is the value of all goods and services produced in the United States. This is regardless of who actually owns the resources used. The percentage change in the GDP, after adjusting for inflation, is considered an important indicator of the condition of the economy. The higher the number, the faster the economy is growing.

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Another consideration in buying stocks is dividends and their yields. This important indicator is the percentage rate of return that is currently realized. It is calculated by dividing the dividend by the stock price. The higher the price of the stock, the lower the yield.

Most stocks that pay a dividend have a more stable price and may not increase in value as quickly as a growth stock. However, the cash dividend increases the value of the stock. These dividends can be taken as cash or they can be automatically reinvested into more shares. Utilities are a good example of stable stocks that pay a good dividend.

The price/earnings (P/E) ratio is an important indicator for buying stocks. Dividing the price of the stock by the company’s annual earnings per share easily arrives at this ratio. If the company has earnings of $1 US Dollars (USD) and the stock sells for $20 USD, then the P/E would be 20.

Another common indicator to consider when buying stocks is the price-to-book ratio. This measuring stick compares the price of the stock to the company’s book value. This can be derived by taking the total assets, minus liabilities, divided by the number of outstanding shares.

Many companies and brokerage programs offer automatic investment plans where shares will be purchase on a certain date regardless of the price at the time. This allows for dollar cost averaging so that your overall purchase price will be more balanced. The professionals often recommend timing the market in this way.

One of the most important things you do not want to do is become attached to a particular stock. Many people fall in love with a particular company and want to own it regardless of circumstances and reports. Something else to avoid are “hot tips.” This form of investing is dangerous and should be avoided. If you hear some advantages in purchasing the stock of a particular company, you should personally investigate it and make your decision based on that. Equally so, when you see risks arising in a particular stock or sector, they should be pursued.

It is important to diversify when buying stocks or investing in general. Depending on your age and risk tolerance, you should have a percentage of your portfolio in stocks, bonds and cash. Stock purchases can be diversified between growth and blue chip stocks. Many people choose to diversify between consumer goods, non-cyclicals, technologies and utilities.

Whenever buying stocks, you should invest in the company for the long term. The buy and hold strategy always works best. Chasing stocks, emotionally buying and selling is only advantageous for the brokerage houses. They earn a commission regardless of whether you are buying, selling, making or losing money. Simply becoming aware of the products and services available in the marketplace and watching what consistently prevails is usually a good way to choose a stock to purchase. Periodically you should re-evaluate your positions and ask yourself if you would still buy the stock today.

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Discuss this Article

tareq999
Post 5

Penny stocks seem to be an average paying investment. I agree with you that following the crowd is not a good idea when it comes to investing. Thank you for the interesting tips you have given on investing in penny stocks.

anon258655
Post 3

I found this extremely helpful. Thanks for the advice.

mutsy
Post 2

@BrickBack - I know that a lot of people say that the biggest disadvantage to buying shares of stock is the lack of diversification, but I think that if you buy companies that you love it will be easier to follow their financials.

This is what my husband’s grandparents did. They bought stock in blue chip companies that they loved. The dividends provided income for them to live comfortably in retirement which was proved to be a great strategy on how to buy and sell stocks.

I also know that through a direct reinvestment you can also buy stocks directly from a company for a small fee. This is great for kids that what to invest their allowance because these types of stock investments allow for small initial investments.

BrickBack
Post 1

I think that it could be intimidating knowing which stocks to buy. I also think that it is riskier to buy individual stocks instead of mutual funds because if there is a problem with the company, your investment gets wiped out.

I would rather buy an index mutual fund. An index mutual fund represents hundreds of companies within a market segment and because these mutual funds are not actively managed they tend to have low fees along with the wide spread diversification.

I am more comfortable doing this then buying stocks online.

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