Investing in the stock market is not as simple as going into a store to make a purchase. Buying stocks involves many steps: setting up a brokerage account, adding funds, and doing research to ensure that you know what you’re getting into before you buy.
Investing in stocks can be a great way to grow wealth over time. It can also allow you to gain more income through dividends if you invest enough. Learn how to get started, how to choose, as well as the risks you should consider.
Key Takeaways
- Blue-chip stocks make good investments for new investors, because they're well-established names with reliable revenue.
- Some investors seek value stocks, which are underpriced when compared to the value of the underlying business. They can make good first investments as long as the companies are fairly large and stable.
- If you want steady income, look at stocks that pay dividends.
- Growth stocks offer the largest potential for gains out of the options described here. However, they are riskier, even more so if smaller firms issue them.
Blue-Chip Stocks
Stocks in companies that are longtime market standbys are called "blue-chip stocks." Even if they are not highlighted in the press, they are generally old and sturdy; they tend to be able to weather changing market conditions and economic storms. Blue chips are great for newer investors; they tend to move with the market predictably. They also carry less risk than most other stocks.
The S&P 500 tracks top companies in key industries in the large-cap segment of the market; many of these are blue-chip stocks. These companies have flourished for years; If you're new to investing, they are reliable choices.
One great example of a blue-chip stock is Walmart (WMT). The chain store has a history going back to 1962. It also has a huge market cap of more than $400 billion and relative stability compared to the market as a whole. In 2020, with more than $500 billion in annual revenue, Walmart held the top spot on the Fortune 500 list.
Tip
The Fortune 500 is an annual list that compares U.S. corporations by total revenue. It's a great place to find blue-chip investment ideas.
Value Stocks
Value investing is the idea that you can find undervalued stocks that look like attractive investments. You can do that by using financial analysis. When you analyze a business and its stock performance, you can find and buy securities that are priced well below their true values. Value investing is the mantra of many famous investors, such as Warren Buffett.
The S&P Global Index measures value stocks by using three factors: the ratios of book value, earnings, and sales to price. Potential value stocks include JP Morgan Chase (JPM), Bank of America (BAC), and the Walt Disney Company (DIS).
Finding undervalued stocks is not always easy. One of the most useful metrics to look at is book value per share, which shows assets compared to the current share price. Other popular ratios include:
- Price-to-earnings ratio (P/E ratio)
- Price-to-book ratio (P/B ratio, also known as "price-equity ratio")
- Debt-to-equity ratio
- Unlevered free cash flow
Warning
Proceed with extra caution when it comes to investing in smaller firms. They are riskier and more volatile than older, stable-value stocks. Also, beware of those that have recently had a major price swing. Those swings and any recent news events surrounding them could influence various ratios and valuation methods.
Dividend Stocks
Some people put their money into markets to see stock prices rise. Others care more about earning cash flow from their investments. If you want your stocks to pay you, dividends are the name of the game.
Dividends are a portion of a company’s revenue paid to shareholders. Corporations often pay them quarterly. Dividends can be paid in cash or reinvested in more stock. When researching dividend stocks, look for a trend of steady dividends (or, better yet, dividend growth) over time. That usually signals a financially healthy company with good long-term prospects.
"Dividend Aristocrats" is a term coined by S&P Global Indexes. Those are firms that have increased their dividends every year for the last 25 consecutive years. They include Albemarle (ALB), Nucor (NUE), and Chubb Limited (CB).
Warning
Investors look very negatively upon dividend cutting, which often follows a period of losses or decline. Be wary of any stocks that cut their dividends.
Keep an eye out for any dividend yields that appear to be too high. Any stock paying a very high dividend should be looked at with a dose of skepticism. It could mean that investors expect the share price to drop or an upcoming dividend reduction.
To find current dividend yields, you can look at your brokerage account or free investment data websites. You can also look at a firm’s investor relations website, annual report, or required public filings for dividend information.
Growth Stocks
Growth stocks are measured using three factors according to the S&P Dow Jones Indices: sales growth, the ratio of earnings change to price, and momentum. Some companies that fit the criteria are Netflix (NFLX), Amazon (AMZN), and Meta (FB), formerly Facebook.
Growth stocks have earnings that grow at a faster rate than the market average. In most cases, a start-up company in an area of interest is likely to be a growth stock. The technology sector is one example. Smaller companies and newer companies are riskier for investors. But some offer strong opportunities for growth.
Growth stocks can come out of any industry. High-tech companies in Silicon Valley have shown great growth prospects throughout the 21st century. These stocks can be companies of any size.
Larger growth stocks are often more stable and less risky, but they provide lower returns than smaller, newer businesses that have lots of room to grow.
Pros and Cons of Buying Stocks
Pros
- Potential for growth to exceed inflation
- Possible revenue from dividends
- Option to pivot when market trends change
- Satisfaction of finding winning stocks
Cons
- Potential losses from unpredictable markets
- Unpredictable dividend payments
- Stress from underperforming stocks
- Difficulties identifying winning stocks
Pros Explained
- Potential for growth to exceed inflation: Inflation is the rate at which the dollar loses value. It's a normal part of any economy. Ideally, your stocks earn a higher return than inflation.
- Possible revenue from dividends: Some stocks pay dividends, or cash payments, to shareholders. They are usually fairly small on a per-share basis, but if you have a large portfolio, you may be able to earn a reliable income from your stocks.
- Option to pivot when market trends change: You can sell a stock with a few clicks on your computer or taps on your phone; this is far more simple than with other types of investments. If you want to change your portfolio, you have the option to do so at any time.
- Satisfaction of finding winning stocks: If you invest in single stocks, it feels great when you hit a winner. You may see your account balance skyrocket.
Cons Explained
- Potential losses from unpredictable markets: There are no guarantees in the stock market. If you pick a bad company or invest at a bad time, it’s a risk. You could lose money.
- Unpredictable dividend payments: Most companies that pay dividends aim to follow a predictable schedule, but there’s always a chance that revenues and profits will drop. On occasion, dividends may stop completely.
- Stress from underperforming stocks: It’s normal for your investments in your portfolio to fluctuate, but for many, this concept is stressful; it can be challenging to get used to.
- Difficulties identifying winning stocks: Actively managed investment funds employ highly skilled and financially savvy managers. They regularly work to beat the stock market; however, most of the time, even they can’t do it.
Beware of Risky Investments
To avoid major losses, ensure that you invest in a diverse portfolio of stocks. Choose from multiple industries and geographic locations. Before you buy any stock, review its recent performance, analyst opinions, competitors, and future landscape.
It could be a buy if you think it is a solid business with good management and great prospects. If you have any concerns or reservations, hold off on clicking the Buy button. Then, wait for a safer investment to come along.
Frequently Asked Questions (FAQs)
How do you know which stocks to buy?
To know what stocks to buy, you need to assess your risk tolerance, financial situation, and investment timeline. These factors can help you target types of investments, set diversification goals, and determine other details for your portfolio. If you need help understanding how these factors impact your investment choices, consult a financial advisor.
What does it mean to buy stocks on margin?
"Margin" refers to funds that are borrowed to buy stocks with. It's essentially a credit line from your brokerage that you can borrow from as needed to trade in your account. For example, you might buy $100 worth of stock and then buy another $20 on margin for a total position value of $120. If the value of your position increases to $200, then you can close your position, pay back the $20 you borrowed, and keep the rest of the $180. Remember, you'll need to repay the margin balance regardless of whether the trade works in your favor or not.
When is the best time to buy stocks?
Timing the market is incredibly difficult, and even those who claim to do it well tend to disagree about the best strategy to use. Many prefer systematic buying strategies, such as "dollar-cost averaging," that avoid trying to time the market.
