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 When we published our article on Penny Stocks, we promised that we would be covering stock research in a future article. But when we started researching this topic, we found the information on the internet is pretty thin. Sure, you can find a lot of articles as well as tools such as stock screeners, analyst reports, and historical quotes. But we really wanted to explain a logical way to go about conducting your own stock research.
Stock Research Explained
To start this series we're going explain what we will be discussing and what we will not be discussing. When we think of the term stock research, we are thinking fundamental analysis. We're not thinking of technical analysis. So if you thinking candlestick charting and volume analysis - some of the elements of technical analysis - we're not going to discuss those approaches here.
Fundamental Stock Research
Fundamental stock analysis is a very business like and logical approach to investing. It is finding companies to invest in that are very likely to return to you value in the form of profits. The challenge is figuring out what you want to own and the price you're willing to pay. But just how does that work?
The best way to explain this concept is with an example. Let's say you're paying a visit to your local Home Depot. You walk in the store and they've got ten brand new snow blowers lined up and they are on sale for only $100. That is a fantastic price, but the problem is that you live in Florida. So you see how this is an important point? You need to balance both - what stocks you want to own and the price you are willing to pay.
Excellent Stocks
To us the most logical approach to researching stocks is to first figure out what kinds of stock you are interested in buying. When we think of the kinds of stocks we would want to own, there are two elements to this decision.
The first is individual because you should own stocks of companies that are in a business that you understand. If gene splicing is a foreign subject to you, then stay away from those companies. The second element of this question is philosophical. Our suggestion is to follow the advice of Warren Buffet and invest in excellent businesses that have expanding value.
Let's explain why we need to look for an "excellent" business and what that means. When we're conducting stock research there are tens of thousands of companies to screen out and choose from. In that universe of stocks there are excellent companies - Coca Cola, General Electric, and Walt Disney to name just a few. But there are also many "commodity type" businesses that should be avoided.
Commodity Businesses
A commodity is generally described as a product that is essentially the same from manufacturer to manufacturer and the primary purchase motivation is price. Oil, rice, steel, lumber, paper, all these products are commodity items. These "second-rate" or commodity-type businesses have certain traits that will allow you to quickly identify them:
- Absence of brand loyalty - that's because brand loyalty usually commands a premium price
- Multiple producers - many companies making the same thing means a lot of price competition
- Excess production capacity throughout in the industry
These three traits translate into low profit margins and low returns on equity - something that investors like to avoid.
Please understand that just because a company sells a "commodity-like" item, does not mean that it is a commodity business. It must exhibit all three of the traits above to be a commodity business.
For example, let's say that in your stock research, you come across the company Starbucks. Well, they sell coffee and coffee beans are traded on the commodity exchange. But Starbucks also has a lot of brand loyalty - so it would not be considered a commodity business.
Up Next Prices Paid for Excellent Companies
Now we should understand that it makes sense for us to invest in excellent businesses and how to identify one. In the next article in this series, we will begin to explain how to figure out the price we might be willing to pay for one of these excellent companies.
About the Author - Stock Research Part I
Bill Sharlow is the Editor of Money-Zine.com. Copyright © 2004 - 2007 Money-Zine.com
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