How I Pick Stocks: Investing for Beginners (Financial Advisor Explains)

[00:00:00] Speaker 1: My friend Kevin texted me last week wanting to know what to look for when it came to investing in stocks, to which I thoughtlessly replied and sent him to a stock screener website where he could look up the vital stats of any company. He replied, dude, there's 72 metrics on the screen alone. This is overwhelming. And I realized that he was right. When you're looking up stocks online, you're inundated with too much information. So I messaged him, don't worry, I got you, man. And so this video is the result of that conversation. And this is the video that I wish I had before I started investing. When it comes to evaluating stocks, there's a six step checklist that I like to go through with every single stock before I even think about investing money into it. And I think that when you're a beginner, you really want to go through this checklist because it's going to give you the highest likelihood of choosing a stock that returns you money in the long run. As long-term investors, we want to be investing in companies with proven track records. So the best strategies for a beginner is as follows. First, if you're new to investing, you want to stick to businesses that you know, and that you use on a regular basis. According to Warren Buffett, never invest in a business that you don't understand. In a world with thousands of stocks to choose from, you're more likely going to be interested in a stock that you intimately understand and a product that you use from that company. So an example that I like to think about is Apple. At least almost everyone has at least one Apple device in their home. So if you choose to invest in the company of Apple, you're more likely to research that company because you at least understand a little bit about it. Second, once you've selected a company, you want to make sure that the economics of that company are pretty solid. Buffett's favorite example is to ask people, how would you go about buying a farm? You're probably going to look at how many acres that farm is, what kind of crops that you can grow on it, what the expected revenue per acre of production is, as well as you're going to look into the costs of what it costs to run that farm and the resulting stream of free cashflow to you. When you're buying a farm, you're buying a piece of that business. And that's what really matters when it comes to investing in stocks. You want to buy solid companies with good business models. I want you guys to take a look at this clip of Warren Buffett being interviewed and talking about how he invests in businesses, because it's going to give us a lot of context for how our mindset should be when it comes to investing. [00:02:03] Speaker 2: How closely do you follow the company? You know, people are concerned they haven't really introduced any new products. [00:02:09] Speaker 3: Well, if you have to closely follow a company, you shouldn't own it. Really? No. I mean, if you buy a business, if you buy a farm, you know, you go up and look, you know, every couple of weeks to see how far the corn is up. And, you know, you worry too much about whether somebody says this is going to be a year of low prices because exports are being affected or anything like that. You know, you buy a farm. [00:02:32] Speaker 1: Isn't that fascinating? Investing isn't that complicated. We want to buy good businesses that are financially sound and play the long game. So how do we do that? So third, we can actually look at how well a company is doing financially based on the holy trinity of accounting statements, the balance sheet, the income statement, and the cash flow statement. By knowing some key metrics of these three statements, you're going to get a really good full picture of what the company looks like financially. This is called doing fundamental analysis on a company. That's when you look at the company's financials, perhaps their management team, and the economic outlook. For the sake of this video, we're not going to focus on technical analysis, which is another type of stock evaluation method. And that's usually used by short-term traders to look at charts and patterns of how well the stock is trading to make short-term trades and short-term speculation bets on those. Now, I'm going to give you guys a simple framework to analyze a company's financial statements. And you can find these financial statements by going to sec.gov and using their Edgar search feature and looking for their annual reports or their quarterly reports. But sometimes that's a little bit complicated and not so friendly for the beginner investor. So what I'd like to actually recommend is you check out Yahoo Finance because they actually have pretty good information on there. I know Yahoo hasn't really been that relevant for the past 15 years, but if you search for a company like Apple on Yahoo Finance, you can easily click on financials and then look at their income statement, their cash flow statement, and their balance sheet pretty easily. The first statement we're going to look at is the balance sheet, which reports on the company's assets and liabilities. I think the two main things you want to assess are number one, what is the company's cash position? And number two, what is their liquidity? To figure out the company's cash position, you're going to want to go to the current assets section of the balance sheet and click on cash and cash equivalents. And as you can see here, Apple has about $62.639 billion of cash. Next, you're going to want to find Apple's debt. So if you click on total liabilities, then click on the dropdown for current liabilities, you'll find the current debt that they have, which is $15.613 billion. You'll also see under long-term debt, under non-current liabilities, that they have $109 billion in long-term debt. Since Apple has $62 billion worth of cash, but only $15 billion worth of current debt, that means they have enough cash to cover their debt for the next 12 months. Their long-term debt also doesn't seem to be an issue as they have more than enough assets to offset their long-term liabilities. In terms of number two, their liquidity, we're going to want to find the current ratio, which is basically current assets divided by current liabilities. What we want to see here is a ratio above one. That means for every dollar that the company owes in the short term, they at least have $1 of current assets to pay for it. So in the case of Apple, it's actually 1.07, which is a good sign. Now, before we get into the income statement, I wanted to share with you guys that Webull is actually giving away 12 free stocks when you sign up and deposit at least one cent. I know that sounds ridiculous, but it's actually 12 free stocks. Webull is an investing app where you can buy and sell stocks. I personally use it on a daily basis. As long as the link is down below in my description, the promotion will be active. So make sure to grab those stocks below there as it directly supports the channel when you use my link. I think it's one of the best promotions on the entire market right now. I don't know of any other brokerage that's doing that. So make sure to grab those free stocks below and let's get on with the income statement. All right. So we're going to look at the income statement to see how the company did in the previous quarter and also the trailing 12 months. This is the document that's going to tell you how much that company made in total revenue. In the quarter ending 6:30, you'll see that Apple made $82.95 billion in revenue. And after all the costs, their net income was $19.442 billion. This shows you that their net profit margin is around 23% if you just take $19 billion divided by $83 billion. So a net profit of over 20% is generally considered pretty good and anything over 10% is still considered okay. What you'll notice is that with healthy, stable companies like Apple, they're going to have a net profit margin of around 20% or even more. But there are some newer companies out there. For example, Lucid Motors, the electrical vehicle company that has no profits whatsoever and might actually be losing money. And in those cases, those companies are going to be a lot harder to value and a lot harder to figure out how their financials are doing. And you might be wondering to yourself, why would someone invest in a company that is actively losing money? Well, here's the answer. Many investors are speculating that growth companies that are losing money right now will turn profitable in the future. And when they do, that will actually yield them a higher return. A famous example of a company that lost money for a very long time was Amazon. So in 1999, they had revenues of $1.6 billion, but they still managed to lose $719 million that year. They were also mocked a lot in the media. Famously, there's an article from NASDAQ in 2003, which is titled Will Amazon Ever Make Money? So while you can invest in growth stocks that aren't profitable just yet, those are going to be more speculative and not every one of them is going to turn out like Amazon. When choosing stocks as a beginner, it's going to be tempting to choose some of those speculative stocks. But if you want a more stable and less bumpy ride, you're going to want to stick to the more stable and profitable companies. The last statement we want to take a look at is the cash flow statement. And this cash flow statement basically details how much money is coming into the company versus how much money is flowing out of the company. Ideally, you want your free cash flow to be growing year over year. And in the case of Apple, that seems to be the case. However, not all companies are going to be growing their cash flow this consistently over time. Free cash flow is a pretty good metric for showing the overall potential of a company and it has three main use cases. The first is to pay down debt because the more cash flow that you generate, the more debt that you can pay off. The second is for dividends and the third is for share buybacks. Strong free cash flows are a good sign of the company's long-term prospects and actually might have shown you that the company has been outperforming the market over time. Okay, so fourth, after you have a good handle on the basic financials of the three statements, what you can do is look at other metrics. And some of the other metrics that I like to look at when doing my rough paths with stocks is going to be the price to earnings ratio. And in the event that that's not available, you can look at the price to sales ratio. So the price to earnings ratio is a metric that many investors will use to gauge the current valuation of a stock. And it's represented as the current price of the share of that stock divided by the earnings per share. You can just look up the P/E ratio on a stock screener like finviz.com or even yahoo finance. And basically what it's telling you is we're figuring out how much we're paying for a given company's earnings. For example, if a company's P/E ratio is 20, that means investors are paying $20 for every $1 of that company's earnings. In general, a high P/E ratio suggests that investors are pricing in a lot of growth for the future for that company versus a lower P/E can suggest that the company might be undervalued. But the real way to tell if the P/E ratio is good or not, or whether you shouldn't invest in a company based on the P/E ratio is to compare that company's P/E ratio against all the other companies in that industry. So companies in the technology sector typically will have a elevated P/E ratio compared to companies in the consumer staple industry. So it's important that you compare apples to apples. So not literally just like the company Apple, but literally apples to apples, you want to keep all the comparisons very similar. Investors such as yourself might find that a stock trades for a good price if the P/E ratio is undervalued compared to the industry average, or perhaps compared to the company itself historically. If the company isn't profitable, then what you're going to have to use instead is the price to sales ratio. And what you'll often notice is that many growth companies will use the price to sales ratio as a benchmark. This is really quite similar to a company's P/E ratio, but basically it's the current price of a company's share divided by the company's sales per share. So if the price to sales ratio is lower than a company that is actually profitable in the same industry, that actually might be an attractive investment. And so people might buy it thinking it's undervalued compared to the actual companies that are profitable. Now, obviously all these metrics need to be taken with context. So don't just stare at one metric and take that in isolation because that might get you into trouble. Fifth on our checklist, we want to look at the company's management team as well as their leadership. You can find out a lot about the management by reading transcripts of companies' earnings calls and annual reports. And you can also research a company's board of directors, check out the executive LinkedIn profiles, and even check out how long the CEO of the company has been working there. Generally, the longer that the CEO has been at the company, that's usually a pretty good indicator because that means that leader has been there for a long time and knows the ins and outs of that business. Most notably, when you have a really key executive leave or a key executive join, you can see that the stock price is usually reflected in that because of people's expectations for the future. And the sixth thing that we want to check out on our checklist is we want to ask ourselves, does the company have a competitive advantage? Having a competitive advantage will give that stock that you're investing in the best possible chance of succeeding in the industry that they're in. For example, AbbVie, which is a pharmaceutical company that I own in my portfolio, owns the exclusive rights to Humira, which is one of America's most popular drugs. Their competitive advantage is the fact that they own many patents on exclusive drugs in the pharmaceutical company so that competitors just can't come up and take their market share. Other competitive advantages for companies could be, for example, brands like Coca-Cola has a huge competitive advantage just because of their branding alone. Or you could also have things like their business model or their ability to innovate. And someone that comes to mind when I'm thinking about innovation is someone like Elon Musk, who's the head of Tesla. All right. Now, if you are a beginner investor, one of the best things that you can do for your own portfolio is going to be diversify your investment across many different stocks, because the last thing you want to do is go all in on one stock, have that stock go bankrupt, and you lose all your money. By diversifying and picking a selection of stocks, what you're doing is basically saying, like, okay, even if one stock completely goes under, at least I have 19 or 20, or maybe even 50 other stocks to keep my portfolio afloat. Now, if you're seeking maximum diversification, what you can do is just invest into a market index fund. By buying that one fund, you're spreading your investment across many different companies that the index fund owns. Index fund investing is one of the strategies that Warren Buffett recommends for almost any investor, as it outperforms professional fund managers most of the time. If you're interested in more index fund investing, I'm going to leave a video up on the screen right now or at the end of this video so that you can check that out after this. I hope that this video helped you gain some valuable insight in how to invest in stocks. We want to be looking at a company's full financial picture and investing in good companies. Make sure to grab some free stocks down below in the description, as well as check out my free newsletter called Hump Days, which comes out twice a week on Wednesdays and Sundays. The link for that will be in the description below as well. Thanks for watching this video. Let me know if you have any questions in the comments. I'll try to get back to you and I'll see you guys in the next one. Peace.