For investors, finding a stock to buy can be one of the most fun and rewarding activities. It can also be quite lucrative – provided you end up buying a stock that increases in price. Below are five tips to help you identify when to purchase stocks so that you have a good chance of making money from those stocks.
When it comes to shopping, consumers are always on the lookout for a deal. Black Friday, Cyber Monday and the Christmas season are prime examples of low prices spurring voracious demand for products – we've all seen the large-screen TV fights on TV. However, for some reason, investors don't get nearly as excited when stocks go on sale. In the stock market, a herd mentality takes over and investors tend to avoid stocks when prices are low.
The end of 2008 and early 2009 were periods of excessive pessimism, but in hindsight, were times of great opportunity for investors, who could have picked up many stocks at beaten-down prices. And after a much-needed market correction in early February, which sent the Dow lower, many deals exist in the market today.
In investing, it is important to estimate what a stock is worth. That way, investors will know whether it is on sale and likely to rise up to this estimated value. Coming to a single stock-price target is not important. Instead, establishing a range at which you would purchase a stock is more reasonable. Analyst reports are a good starting point, as are consensus price targets, which are averages of all analyst opinions. Most financial websites publish these figures. Without a price target range, investors would have trouble determining when to buy a stock.
There is a lot of information needed for establishing a price target range, such as if a stock is being undervalued. One of the best ways to determine the level of overvaluation or undervaluation is by estimating a company's future prospects. A key valuation technique is a discounted cash flow analysis, which takes a company's future projected cash flows and discounts them back to the present. The sum of these values is the theoretical price target. Logically, if the current stock price is below this value, then it is likely to be a good buy.
Other valuation techniques include comparing a stock's price-to-earnings multiple to that of competitors. Other metrics, including price to sales and price to cash flow, can help an investor determine whether a stock looks cheap compared to its key rivals.
Relying on analyst price targets or the advice of newsletters is a good starting point, but great investors do their own homework on a stock. This can stem from reading a company's annual report, reading its most recent news releases and going online to check out some of its recent presentations to investors or at industry trade shows. All this data can be easily located at a company's corporate website under its investor relations page.
Assuming you've done your homework, properly identified a stock's price target and estimated if it is undervalued, don't plan on seeing the stock you bought rise in value anytime soon. It can take time for a stock to trade up to its true value. Analysts who project prices over the next month, or even next quarter, are simply guessing that the stock will rise in value quickly.
It can take a couple of years for a stock to appreciate closer to a price target range. It would be even better to consider holding a stock for three to five years – especially if you are confident in its ability to grow.
Legendary stock-picker Peter Lynch recommends that investors buy what they know, such as their favorite retailer at their local shopping mall. Others can get to know a company by reading up on it online or talking to other investors. Combined with the above tips, applying your own common sense in choosing when to buy a stock can produce the most profitable results. To jump into the stock trading or investing world you'll need a broker. Check out Investopedia's list of the best online stock brokers.