How Do You Decide to Buy a Stock?

Jan 7, 2015 -

Let's not kid ourselves and cut to the chase. We will only buy stocks if we think at a later time we can sell it for more than we had purchased it for.


Buy into a Company for Future Earnings and Potential

A stock represents an ownership interest in a business. While buying a handful or even couple thousand of shares will not grant you significant influence over say an Apple or Google, but you still technically have a say. That means you have voting rights when it comes to electing directors and fundamental changes that affect the company such as mergers and acquisitions.

There are different ways to value that piece of ownership. One way of doing this is asking yourself what would you pay for the entire business? Then ask yourself is that stock worth that portion of the entire business?

If the business does well or is projected to do well then in theory we would expect the stock to do well also. Of course, it is not a direct correlation all the time. The market dictates the price and like things sold at the supermarket, sometimes it will go on sale or be marked up. However, in the long run, you would expect the stock price to catch up to the company's profits.

Bottom line is that if you believe that a business will continue to increase profits and grow market share, then you should buy it now because in the future it will be worth much more than you paid for it. Having said that, a couple of companies you might want to do some research on are Alibaba (BABA) and Tesla (TSLA).

Collect your Passive Income Now

Let's say you are looking for passive income. Something that will give you money for little or no work at all. Maybe you've considered buying investment real estate property. Every month, your tenant sends you a check for rent. That sounds great, but usually there are a couple other hoops to jump through. First of all, you'll need to find a tenant. Then of course if anything in the house breaks you'll have to go and fix it or find a handyman. What happens if your tenant doesn't pay on time? Oh you might have to chase them down for payment.

There are alternative forms of passive income. Buy dividend yielding stocks. These are stocks that pay a portion of their earnings or profits to their shareholders. In most cases, these companies are large established profitable businesses that have enough money to reinvest a portion of their profits and payout to shareholders.

Dividends are usually paid out quarterly and depending on the company can yield more than 10% of their share price a year. Typically, Real Estate Investment Trusts (REITs) offer the highest investment yields to their shareholders. The main reason is that they are obligated to distribute at least 90% of their taxable income to shareholders in the form of dividends. REITs allow investors to invest in real estate without having to deal with the shenanigans of purchasing and maintaining property.

However, like other stocks, these REITs are subject to market fluctuations. But, if you are not looking to sell, then these dividend yielding stocks can provide for a decent passive income stream. Companies such as American Realty Capital Properties (ARCP) and American Capital Agency Corp. (AGNC) both yield annually at around a 12% dividend rate.

Flip a Stock and Make a Quick Profit

Undoubtedly, stocks are subject to market fluctuations. As I had previously mentioned, stocks may be trading at discounts, but there can also be times when they are severely overvalued. For example, in 2008-2009 the financial crisis hit and that caused many stock prices to fall more than 50%. Had you had the insight into that, you would've bought then and there as you've now seen stock prices reach all-time highs.

There are a number of ways to determine whether or not you are at the low or high end of a price range. The first question you ask yourself is, is the stock undervalued in the short term (weeks or months)? Technical analysis is the technique in which you analyze whether or not the price of a stock is over or undervalued in the near term. In other words, with a level of certainty you determine when to buy a stock based on their stock chart.


For example, some stocks will trade in price ranges. This means the stock will fluctuate from say $12 to $14. The simple strategy is to buy when it is $12 and then sell when it is $14. You thereby make about a 16% profit. Now this doesn't always work, but for five months in 2013 this was a great strategy for trading Clean Energy Fuels (CLNE).


Another example is a what we call in technical analysis as a descending channel. For about seven months in 2014, Deere & Co (DE) declined from about $93 to $79 per share. This whole time we drew a channel to track the price. There isn't an exact science to drawing the channel, but the more points the chart touches the line the more accurate the channel. When it finally broke outside of the channel, we bought at $82. If you check the stock now, it is trading upwards towards $85 per share now.

If you are looking for more technical analysis patterns, I would highly recommend looking into the below stock chart books.

    


 
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