Finding the Best Stocks to Buy

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As investors, it's important to know how to go about finding the best stocks to buy. Before it's possible to successfully choose the best stocks, you first have to understand some of the fundamentals of evaluating these securities. For example, what are the desired characteristics for a stock?

What Stocks to Buy?

The answer to that question is fairly straightforward: You are trying to figure out which stock to buy, before the rest of society wants to buy that same stock. It's called the stock market for good reason. It's a very efficient market, one that follows the law of supply and demand. As an investor, you want to buy a stock just before demand for that stock increases. This means you need to buy an "undervalued" stock.

Additional Resources

Now that we know what kind of stock we want to buy (undervalued ones), we have to be able to identify the specific companies in which we'd like to invest our hard-earned money. There are roughly 3,000 companies listed on the New York Stock Exchange alone, so unless you have a lot of time, we need to quickly narrow the list. The following guide will help you through that process, but there is no substitute for conducting your own research.

Researching Good Stocks to Buy

In fact, the entire approach outlined below is based on a series of articles dealing with the topic of stock research. We've already addressed one topic in our article entitled - the Ten Best Stocks to Buy. In this publication, we're going to discuss the mindset you should have when you're trying to decide if buying a particular stock makes sense for a serious investor.

Pick a Market Sector that You Understand

Many people like to play the market on gut, but we're not comfortable buying shares of a company that is in a business we don't even understand. We'd rather spend our time focusing on sectors that we know and understand, rather than learning about topics such as nuclear physics.

That means focusing on business sectors that we interact with daily: car manufacturing, toothpaste, or lawnmowers.

Pick a Stock with Real Value

The best stocks to buy will be those that demonstrate good fundamentals. Now some of you might be thinking - this magazine is old school; they aren't even going to mention technical analysis. Well, you're correct in that thinking.

Technical analysis is the study of trading patterns and historical prices of a stock. If you've ever been a day trader in a bull market, then you might be forever sold on technical analysis. The techniques described in this publication rely more on in-depth stock research.

Fundamental analysis means you are looking at, and comparing, Price / Earnings ratios, book value, cash flow, and return on assets. If you're not familiar with these terms, then take a look at our article on Understanding Financial Ratios.

Basically, you are looking for stocks with real intrinsic value. Something we discuss at length in our third publication on stock research.

Avoid Stocks with Potential Liabilities

There are many stocks to choose from, so it is a good idea to stay away from stocks that are in the news because of large and looming lawsuits. Legal problems can drag on for years and lower a company's stock price, so your best bet is to steer clear of companies that have legal problems.

Look for Companies with Bright Futures

Although past performance might be a good indication of future returns, the reverse can also be true. If you find a stock with good fundamentals, then make sure you look at the predictions of the analysts that track the stock. At the very least, make sure they are predicting stable or growth in earnings per share.

If there is one lesson everyone has learned from the dot-com bust of the 1990s, it's that companies need to be profitable to remain in business. Don't be confused when people start talking about revenues. A company can have a huge revenue stream, but earnings are the measure of a company's profitability. If you're serious about investing in the stock market, then you need to understand fundamental research topics such as earnings per share estimates.

Finding a Stock that is Not Popular

This is probably one of the most difficult things to do. You want to pick a stock that is not popular today, yet could be popular tomorrow. Remember, it is supply and demand forces at work in the market. If a stock is popular, then this means that demand has already pushed the price higher. You want to find a "sleeper" stock. This is a stock that is currently being ignored by the market, but has the future potential to rise in price.

If you follow these guidelines, then you should stay one step ahead of the crowd. By finding a fundamentally strong stock in a sector that you understand, you should rest comfortably knowing that you picked a stock with the potential to provide for rewarding returns.

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