What should You check before buying a stock ? (Beginners to Intermediate Guide)

Updated: Jan 15

Before I start I would like to let you know that this topic is not for day traders, I do not recommend day trading as I believe it's a total gambling and 90% of traders loses money. Day trading offered by eToro, plus500 and many other similar platforms. In Day trading you do not actually own a stock but you are betting on it. Buying a stock means you actually receive a certificate of ownership, you have voting rights and you are entitled to receive dividends, please read my previous article for detailed information.

Click on this link (How to start investing in the stock market?) Now let's start talking about some more advance things.

Whenever you want to buy something you always want to make sure that a particular thing gives you the maximum amount of benefits and the same thing applies to the stock market. The easiest way to identify a good stock is to check the Market Cap of a Company. The Market Cap means total amount of shares on issue x share price = Market Cap. In short its the total value of a company given by share holders on Market. Once you start looking for stocks you will see Market cap in details of any particular stock, However this is only one of of many things of identifying a good stock, you also need to know the health of company's balance sheet and many other things which I am going to discuss next.

Large Cap Stocks ( Low risk, low return and dividends)

Most Companies you know are most likely large caps. Everyone knows those companies because they are very successful and popular companies, as an example Apple is a Mega stock with market cap of about $1.99 Trillion USD !. Apple has been performing very well from last so many years, However even Many large caps are not performing always good so there are also other things needs to be checked before buying a stock. As an example Telstra's Market cap is $33 billion AUD however it hasn't given a good return on share price from last so many years and many investors have even lost money on it. Telstra is a stable dividend paying blue chip stock but we also need to make sure that you are not losing money from share price drop due to poor performance of the company or because of poor management.

Mid Cap (Medium risk, medium return and dividends paid by some companies)

Mid-cap means companies with a market cap between $2 billion and $10 billion and only some of them are profit making companies. As an example Perseus Mining ltd (PRU:ASX) is a Mid cap stock. Perseus Mining ltd doesn't pay any dividends, however PRU:ASX has given a good return in last few years such as last 5 years return was 243.8%, last 3 years return was 292.2%, last 1 year return was 48.5%. Here is the example of a worst performing mid cap stock. New Hope Corporation ltd, (NHC:ASX) is another mid cap stock has given 1 Year return -50.4% , 3 Year return -43.4% and 5 Year return -41.6%.

Small cap (Medium to High risk, Higher return and no dividends paid)

Small cap means a company's market cap with roughly about $300 million to $2 billion. As an example Sezzle INC(SZL:ASX) is a small cap stock with market cap of $715 million which has given 186.5% return in last 1 year, however last 5 and last 3 year return was NIL so it's doing well from last 1 year only.

Micro Cap (Very High risk, Higher return)

Micro cap means a company's market cap starts with less than $1 million to $50 Million in my opinion. Micro caps have very high risk of getting bankrupt, however if the company becomes a successful business then it can even give Impressive return like 1000% to 2000%. However investing into Micro caps is almost like a gambling and very risky.

Now I am going to tell you about things to consider before buying or investing in any particular stock.

Things to Consider Before Buying a stock.

1. Invest in a stock with a good size Market Cap.

I would suggest beginners to invest in large cap stocks to reduce risk on your investment at the beginning stage. Once you have 1 to 3 years of stock market experience you can start taking a bit of more risk on Mid, small or Micro cap stocks. Even if you are experienced investor, I would suggest you to invest majority of your money on dividend paying large caps and you can take a bit of risk on Micro to Mid cap stocks.

2. Company's Health.

You should check company's health even if company has a large or small market cap. You need to read company's latest quarterly or yearly report or read balance sheet. If the company has too much debt compared to total assets then I would stay away from that company because that Company can go bankrupt even if it is a large cap stock. The easiest way to find out company's health is by downloading Simply wall st app or use website. They have a free plan where you can check up to 10 companies per month for free, however sometimes their information is not up to date so verify about company's health through 2 to 3 different sources.

3. Stay away from loss making Companies with Negative or no P/E ratio.

You should stay away from loss making companies because there is more risk of losing your money. Check company's quarterly or yearly report. Normally companies without P/E ratio or with negative (minus) P/E ratio are loss making companies. You can find out P/E ratio in stock's financial details in a broker app or on the website.

4. Do not invest if you don't understand the business.

If you don't understand how a particular company's business works or don't have knowledge about that particular industry then do not invest.

5. Diversify your investments.

Never put all the eggs in one basket. As an example if you want to invest total $10,000 then invest in 5 or more different industries, so if you invest $2000 in a Gold stock, $2000 in Media stock, $2000 in Health care stock, $2000 in Retail stock and $2000 Telecommunication Company then you are doing proper risk management. If you put all your $10,000 in only particular industry and if that industry crashes you will lose all your hard earned money, But if you have diversified your portfolio then you reduce the risk of losing all your money as an example if the banking industry goes down then on the other side Gold industry may go up. So diversification of your portfolio is very important.

6. Buy Undervalued stocks with high potential.

There are many ways to find undervalued stocks. As an example, if you want to buy a cheapest energy stock from oil and gas industry then you can find out by comparing P/E ratios of similar companies. As an example if you compare current P/E ratios of Woodside petroleum ltd P/E 27.11 with Santos ltd P/E 19.35 and with Beach Energy ltd P/E 6.81 then you get Beach energy ltd is the most cheapest stock amongst all those three.

7. Control Your FOMO( Fear of Missing Out)

I have seen many times people rushes to buy stocks first and then they do research and later realizes that they made a mistake. Its better to miss out than lose money, remember you may miss some but not all, if you do proper research there are many opportunities out there waiting for you.

8. Read Charts.

Chart is a great source to quickly check Company’s Performance. You need to check long term(5 years) , Medium term (6 months) and Short term(1-3 Months) trends of any particular stock. You may find that the price has continuously declined over long period of the time, which means that stock is not performing well if the price is continuously rising that means that stock may be a good stock. Make sure that the stock is not overvalue. however you should never make your investments decision based on chart only. You need follow all the investment fundamentals before buying a stock.

(More tips will be added soon. Stay Tuned)

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Note: This is not a financial advice, Please do your own research and make your own decision.