If you are like most people today, you have either thought about investing in the stock market or you actually went out and bought some stock. If so that's great, there is lots of money to be made in the stock market, but the important question is: How do you pick your stocks?

 

  *   Are you buying the stock, because your brother told you to?
  *   Did you get a hot tip from your mailman?
  *   Or are you just buying the stock because you like the company's products?

 

Believe it or not, a very large percent of people who invest in the stock market are investing their hard earned money based on the above examples without any further research.

 

Does this sound like a smart way to invest to you? It certainly doesn't to me.

 

Now if you ask your brother what stock to buy and your brother happens to be Warren Buffett, well then I think its safe to say you will make a good investment, but how many of us can claim Warren Buffett as our brother?

 

For the vast majority of us this kind of investing is very risky, while you could make money, it is more probable that you will lose money.

 

To help you keep from losing your money and to help you make the best choice when picking stocks, below you will find the five most important questions to ask yourself before buying a stock.

1. What Does the Company Do?

   This sounds like pretty basic information, but it can be tough to find. Most companies offer more than one product; a big conglomerate might offer hundreds of different products in a range of industries. Digging into the company's lineup can give you a better sense of the forces that will drive its results. Scrutinizing a company's product line cans also tell you where its profits come from. For example: video games accounted for 11% of Sony's SNE total sales in 2000 but 40% of its earnings.

   The annual report is the best source for this kind of information. Be sure to read the shareholders letter, as well as the presentations of the company's product lines. Those are also part of the company's SEC filings.

    

2. How Fast is the Company Growing

   Over long periods of time, stock prices are driven by earnings growth. That can come when a company cuts costs, but ultimately, revenues have to increase if earnings are to keep going up. If revenues, also called sales, are increasing, that's a good indication that something is working. Maybe the company boasts a better-than-average product or a more effective sales force. In contrast, flagging sales can signal trouble.

    

   Earnings growth signifies that the company is making more that enough to offset its costs. Established companies should show consistent results, but young companies often display strong revenue growth with little or no earnings. Witness the myriad of Internet companies with lots of sales and no profits.

    

3. How Profitable Is It?

   In addition to growth, look at how efficiently the company makes money. Return on assets shows how well it has translated a dollar of its asset base into a dollar of profits. A company with a return on assets of 20%, for example, has produced $0.20 of earnings from each dollar of assets. Similarly, return on equity measures how well the firm has turned a dollar of shareholders equity into earnings.

    

   Measures like return on equity and return on assets help you understand how efficiently a company allocates its resources, and they allow you to look beyond raw profit numbers. Companies with the same earnings figures might have very different returns on equity and returns on assets, depending on how well they have turned their assets into profits.

    

4. How Healthy Are Its Finances?

   Earnings and cash flow are two different things. You could earn a very generous salary but still run into cash-flow problems if you get paid only twice a year. Because of quirks in accounting practices, a company's reported earnings often differ from the amount of cash it brings in the door. The statement of cash flows, which is part of the annual report, will tell you just how much of the money a company pocketed.

    

   It's also important to see how the company uses that cash. Digging into the cash flow statement to find out where the money's going can shed light on management's strategy and give you additional insight into the company's future. Is it building aggressively for the future by opening new stores or building new manufacturing facilities? Is it buying other firms, paying off debt, building up cash reserves, buying back stock, or paying dividends?

    

   Companies can also issue debt to finance new plants and research efforts or to bail itself out of short term cash problems. Companies need to watch their debt levels, though. Too much borrowing can force the company to use its cash to pay interest, instead of applying it to more productive ends.

    

   No hard-and-fast rule will tell you how much debt is appropriate for a particular company, because levels of indebtedness can vary across industries. To get an idea of whether a company is overburdened by debt, divide its assets by its equity. The result is the company's financial leverage.

5. Is It Worth the Price?

   company might clear all these hurdles, but sell at too high a price to be an attractive investment. It all depends on how much its prospects are worth.

    

   To figure that out, look at its forward Price/earnings ratio, for example General Electric has a forward P/E of 41, which means that the shareholders now pay $41 for $1 of the company's future earnings.

    

   Another widely used measure is the price/book ratio. That shows how much shareholders are paying for $1 of the company's assets.

 

Some Tips About The Stock Market For Beginners

 

There's probably no one that doesn't wish that they had a better understanding of the stock market. For beginners, it can seem overwhelming and confusing, and perhaps even a bit frightening when you hear about the stock of well-known companies going up and down like a roller coaster. But if you're a beginner looking to get your feet wet in the stock market, or just want a few pointers on how to pick some good stocks, we have some tips and pointers for you. Explaining the stock market for beginners is not as difficult as you might imagine.

 

 

Everyone is Confused

When considering how to get involved in the stock market for beginners, it's important to remember that even the most experienced expert in investing can be confused as to which stock to pick. The laws regarding stocks change constantly, as do business practices and industries. There are so many factors that will affect a stock's performance that it's absolutely impossible to be completely certain of any decision or investment you make.

 

This might seem a big frightening to the beginner that is hoping to hear that there is some magic formula or method for making the right decision, but it should be reassuring to those interested in the stock market for beginners. It means that if you make a wrong decision then it's not necessarily because of anything you've done wrong. Anyone and everyone can and will lose money in the stock market; the key is just protecting your investments and having a well-balanced portfolio so that your gains outweigh your losses. This is probably the most important part of the stock market for beginners.

 

A Balanced Portfolio

You may have heard the phrase "a balanced portfolio" when it comes to the stock market for beginners and have wondered just what that means in more detail. A balanced portfolio doesn't mean just investing in different types of companies, but in companies that will offset each other in case one has a loss due to a change in the industry.

 

The best way to illustrate this is to consider an investment in both airlines and crude oil. When crude oil goes up in price, airlines need to raise their rates to offset the price of gasoline. When they raise their rates, their stock typically goes down. However, the increase in price of crude oil means that its stock will probably go up.

When discussing the stock market for beginners, you need to think of how your different investments will offset each other so that if one goes down, your others are likely to go up. This isn't to say that you should necessarily invest in oil and the airlines, but to make your decisions based on what will keep your portfolio balanced in this way. You need a mix of stocks that offset one another so that when one goes down another will go up. This is one of the best and most basic tips about the stock market for beginners, and one that you should always remember when making your choices.

 

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Know Your Tolerance for Risk

It's typically true that the higher the risk, the higher the reward and this is true when discussing the stock market for beginners. Most stocks that are going up quickly are not going to continue to rise at such a rate and will need to level off at some point. They may also be start-up companies that are just getting off the ground and investors are parking their money in their stock based on what they think will happen with the company in the future. When considering the stock market for beginners, you need to remember that these companies may have high yield but are also very high risk.

 

Putting all your money in these high yield but high risk investments is one of the most common mistakes made in the stock market. For beginners, you need to remember that this too is part of a balanced portfolio - some investments might be high risk but keep a lot of your investments in those that are going to perform well over the long run as well.

 

Practice!

When you can, it is often good to practice a skill before testing it in the "real" world. See what works for you - and what doesn't without risking your capital.

 

Keep Trading Fees Low

As you only have so much money to invest, do your best to keep your stock trading fees low.