Should I factor in market caps or returns more heavily when deciding what companies to invest in?
I'm new to purchasing stocks. Should I factor in market caps or returns more heavily when deciding what companies to invest in?
I wouldn't give either much weight (depending on what you mean by "returns.") In order to be a successful long term investor you need to buy a diversified collection of well-run, profitable, growing, financially sound companies. It does not particularly matter if these companies are large-cap, mid-cap or small-cap (though many would argue that smaller companies give higher long term returns, it's not a clear correlation).
Look at ROIC and free cash flow for indicators of future financial health. They are much better valuation tools than P/Es. Get to know companies over time before investing. Then, when a market dip affords an attractive entry point, buy.
The market cap tells you how big the company is (in terms of its value to shareholders) and the returns tell you how well the stock has performed in the past. Neither of them tells you how the stock will do in the future. To select stocks using fundamental factors you must understand how much the company earns, how much you are paying for those earnings (Using ratios such as P/E) and how much those earnings are expected to grow. You also want to learn how the company earns money and the quality of the management.
Selecting stocks is a lot of work before purchasing and then after purchasing to monitor it. If you are not able to put in the work, you should invest in a diversified portfolio of stock using low cost investment vehicles.
Stock prices go up because the markets feel that the company will have rising profits in the future. It doesn't matter if it is a small/large company, or it had good/bad returns in the past: you need to look in the future. My recommendation is that you take a look at the companies that have products you personally consume. If you like them, there is a good chance you are not the only one.
Buying a portfolio of company stocks that are meeting what Americans are looking for should have rising profits, therefore should have rising stock prices.
I hope this helps.
If you're new to investing, I'd recommend focusing on building a diversified, low-cost mutual fund (or ETF) portfolio. Picking stocks is incredibly difficult to do consistently. Index funds outperform the vast majority of professional, active managers. Any hope that you or I could do better is probably unrealistic.
Instead of picking individual stocks, follow a few simple investing fundamentals like:
- Get yourself ready to invest by first paying off consumer debt and building an emergency fund
- Stay tax efficient
- Understand your personal risk tolerance
- Keep costs low. The lower the fees, the more of your portfolio you get to keep!
- Rebalance periodically
- Stay the course! Don't bail out of the market when prices drop!
History shows us that regular investments, diversified across the equity markets and rebalanced periodically outperform other more "professional" investing strategies.
Get started today! And good luck!