The One Hour Project: Thoroughly Research A Stock

This post is part of The One Hour Project, in which you can spend just one hour to put your finances in a better place without a big lifestyle change, through frugality or other financial choices.

Regardless of whether or not you include individual stocks as part of your investment plan, having a general idea of how a stock works can be an incredibly valuable piece of knowledge to have. Even for those who only invest via a retirement plan, that retirement plan is usually just a collection of stocks, so knowing how stocks work can help teach you how your retirement plan works – and it might give you insights on how to invest your money more effectively.

What can be gained from this?

First, you’ll get in touch with your risk tolerance. Most stocks, over the course of a small period like this, stagger up and down a little, and possibly see a big lurch. If you imagine that you have some significant money in the stock, the sight of it going up and down day after day will probably tell you whether you can stomach this particular roller coaster or whether you should be investing more conservatively.

It will also likely show you how different news reports affected the stock you were looking at and thus how news reports affect stocks. The Federal Reserve cuts interest rates and your stock goes up. The company exceeded earnings expectations by a cent and the stock goes up. A competitor brings out an amazing new model and the stock goes down.

You’ll also learn what a lot of basic stock investing terminology means. This will help you to understand a lot of financial news and also help you to understand your own investment choices.

If you’re already into individual stock investing, your research will probably tell you whether you would buy into this company or not. This research will at least somewhat indicate whether the company is in line with what your investing philosophy is and whether you believe you can make some money from the stock.

Here’s what you do.

Identify a company you’re interested in. I often identify companies based on the quality of their customer service – if I have a great customer service interaction with a company, my impression of that company goes way up and I’m much more likely to want to do business with them in the future. Of course, the reverse is true – atrocious customer service drives me away.

Just select a company that you’re somewhat familiar with as a customer, either directly or indirectly. For this example, I’ll talk about Herman Miller (MLHR), a company that produces office furniture, including the exquisite Aeron chair.

Investigate the company. Find out how their business is doing. I usually start at the Yahoo! Finance page for a particular stock, so here’s that page for Herman Miller. I usually also check Google’s info on the stock.

Here are a few big things to look for:

Recent news developments and how they affected the stock This is easy to find on the Google page for the stock. What sorts of recent events had an effect on the stock price? Their graph of the recent stock history identifies recent news reports and points to when that event occurred, so you can see what affected it.

How the competitors are doing Look at the company compared to the competition, which can be found on the Yahoo! page. Compare their earnings per share (EPS, how much money the company is making per each share of stock out there) and their P/E ratio (price/earnings, which means how valuable the stock of the company is compared to how much money the company is actually making). You might want to actually peek at each competitor in more detail.

What the company’s insiders are doing Take a look and see what the people involved with the company directly are doing. Are they selling a lot of stocks without anyone buying any? That’s a bad sign. A lot of buying is often a good sign. Don’t be scared away by a little bit of selling – they might be selling the stock to build a home or something – only be worried if several different people are selling stock.

Obviously, this is just a start. Take your time and don’t get lost here – if you don’t know what any word or term means, stop and use Wikipedia to look it up. Use this investigation of a company you’re interested in to find out what a P/E ratio really means and why it’s important, for starters.

Once you’ve invested some time in this, put it on the back burner for a month. Check in on the company news about once a week and see if there’s been any big change, but let it slide for several weeks.

Then, when you have a bit of time, go back and trawl through all of the information again. Has your feeling on the company changed? Do you think it’s doing good business or bad business? Generally, if you can’t see any big problems, it’s doing just fine. It also doesn’t matter whether you’re an expert – the best analysts on Wall Street have at least as much trouble with these questions as you have.

The purpose here is to learn a bit about how stock investing works so that when you have to make a choice about investing, you’re not completely out in the blue. Plus, you might learn a thing or two about your favorite company – a friend of mine got really into this exercise and found out all sorts of interesting – and a few disheartening – things about the large corporation he works for and the soundness of their business. It started off as a learning exercise; it ended with him restructuring his 401(k) plan.

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15 thoughts on “The One Hour Project: Thoroughly Research A Stock

  1. Kay says:

    Trent,
    THis is great advice. I am reading so many stock references, its hard to pick out advice on a stock and how to research one.

  2. Mrs. Micah says:

    Indeed. If I’m hired with my company and get to participate in their 401(k) plan, then I have to take Fidelity, not Vanguard like I want (unless I can find a loophole, maybe that’ll be another 1 hour project). So perhaps I can find a good Fidelity index fund.

  3. Amanda says:

    The best way to get started with individual stocks is to buy them – on paper. Make a stock-tracking spreadsheet, and track the price of stocks that you “buy” for a week or even longer. Notice the trends. Read up on techniques like technical analysis. Your picks have a 50% chance of going up, and a 50% chance of going down, all things being equal. The good stock picker gets a feeling for the market and is better able to choose those that will get up. That is, his portfolio might have a 60% chance of going up and a 40% chance of going down.

    This is how I learned. Practice. It doesn’t cost any money (initially) and it’ll give you a decent feel for the market.

  4. dong says:

    Amanda, actually stocks really have a better than 50% chance of going up – just the nature of the stock market and the nature of businesses growing, and the beauty of investing. Otherwise, I agree I think investing in paper is great way to start.

  5. Amanda says:

    They might have more than a 50% chance of going up, but what’s the chance of staying up? :)

    The stock market is being artificially inflated right now by the Fed. They’ll lower the fed funds rate again in October, but they can’t keep that up for long. When they stop trying to prop up their banker friends, it’ll be a bad time to be in the market.

  6. Andrew Stevens says:

    I’m not actually sure Dong is correct. In the aggregate, stocks have a better chance of going up than going down, but that doesn’t mean that the majority of individual stocks go up. It could just mean that the gains of winning stocks outweigh the losses of losing stocks. I won’t venture a guess as to what the percentages actually are, though.

    In general, individual stock prices, in theory at least, are a “random walk,” if you buy the efficient market hypothesis. The only objection I have to the 50% chance of going up figure is that the price does include an assumption that it will appreciate at at least the risk-free rate (i.e. whatever U.S. Treasuries are currently paying). This doesn’t necessarily mean that the chance of its going up is higher than 50%, only that its expected gains times the probability of gaining are higher than the expected losses times the probability of losses.

  7. A nice post on researching stocks by Trent! Our two cents – perhaps it would also help if we also spend some time to understand which stock index we need to follow, esp. when we are planning to buy index funds or ETFs. We found from experience that this an area where information is not so easily found!

  8. vh says:

    Mrs. Micah… I’ve had both Vanguard & Fidelity in my 403c, and also have an IRA with Fidelity and a Roth IRA and regular mutual funds w/ Vanguard, all on the advice of a financial advisor with an awesome track record.

    In the retirement fund business, Fidelity seems to serve its customer base a lot better than Vanguard. VG’s statements were always late–sometimes I had to call up, navigate the annoying punchabutton phones, finally get a real person, & beg them to send me a statement. After my employer dropped VG and I had to switch to Fidelity, I found Fidelity sends statements on time.

    In other contexts, Vanguard is great. But when you deal with VG through your employer’s retirement plan, it’s like an entirely different corporation.

  9. Kate says:

    This is a great post but I urge people to be careful when using Wikipedia for research. I don’t deny that it is a wonderful source of information but, because it is a wiki, anyone can edit an article and add information that is incorrect.

  10. Jon says:

    Another thing to focus on in your research is to find out the biggest risks to the company’s profitability. There are obvious ones that apply to pretty much all companies and there are hidden ones that don’t show up in casual research.

    An example of an obvious one is debt. If a company is hugely in debt and interest payments are rising every year, that’s a factor that you need to investigate — are they taking on new debt and putting it to good use or are they sinking in it? It doesn’t matter if it’s an oil tanker company or a fast food company.

    An example of a relatively hidden risk would be how interest rates affect utility companies. If you go read about a specific utility company, chances are you won’t see them issue a big press release that says “Our stock may fall quite a bit if the government raises interest rates.” Why does it happen? Well it turns out a lot of people invest in utility companies just for the dividend, which is often several percent, for things like steady retirement income. When interest rates rise, people take their money out of utilities and put them in treasuries or high-yield savings accounts, and the stock falls. I don’t know, maybe that’s obvious to some people, but it wasn’t to me!

    This is why a lot of famous investors (Warren Buffet, Peter Lynch) tell you to buy what you already know. Casual research often won’t give you enough information for you to know all of the risks, unless you already have background in that industry.

  11. justin says:

    Wouldn’t it be better to research investing in general, and just stick to index mutual funds?

  12. Rob in Madrid says:

    If your interested in picking stocks you might want to check out Share Owner magazine (over at shareowner.com) my dad subscribed for a while but decided against investing in individual stocks. The stock selection guide teaches you how to select stocks .

  13. Nate says:

    Trent,

    Great post on an overview for individual stock investing. If I could add a few things that would help a potential investor.
    Read the 10-k and 10-q for the most recent year, skim the 10-k’s for the last five years. Read the auditor’s letter first, then the footnotes, then the balance sheet/income statement/cash flow, then the MD&A. Look for changes in accounting methodology, or aggressive accounting. Also a big red flag is a change in auditing firms.
    Another red flag is if in the presidents letter attached to the annual report the word “challenging” is mentioned three or more times. If so sell ASAP, no further research is needed.
    Next look at items like the debt/equity, free cash flow, long term commitments. If possible go back five years or so to get a gauge of earnings quality.
    If after all of this you still haven’t ruled the company out determine the intrinsic value, and if you’re comfortable purchasing the issue at the current sales price.
    If this seems like a lot of work it it..but then again there is real money on the line, so a few hours of work to save tens of thousands of dollars is worth it in my book.

  14. Jim Lippard says:

    Mrs. Micah: I’ve been very happy with Fidelity (and especially the Fidelity Diverse International Fund). They also have some retirement funds that automatically change allocations over time as you approach retirement age, the Freedom xxxx Funds, where xxxx is your planned year of retirement.

  15. Trent-

    This is a great post on investing on a great site about managing your money better. This thread shows how hard it is to invest wisely- way too hard. I am the Founder and CEO of a new investing site called Cake Financial that aims to make it much easier than existing options. It’s secure and free and it allows all of us to do what we are doing here and collaborate in real time what we are all doing- without revealing any sensitive information like how much money we have.

    Please check it out and let me know what you all think!

    Best,

    Steve

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