The stock market is a very rugged terrain even for the experienced investor. Therefore, for a new investor looking to buy their first stock, the going might prove to be tough before one can identify the perfect stock to invest in.
To shorten the task of choosing your first stock, it is good to know that there is no perfect stock. Any stock could be the best for you depending on circumstances surrounding your investment profile. Most people buy stocks because somebody has recommended one or two to them. Others buy because someone they know invested in stocks and became rich.
One of the main items to look at in an investor’s risk profile is the amount of cash they are willing to commit to the stock market, as well as their financial ability. For instance, if you only have $500 to invest, it would be unwise to try to buy shares of Apple (AAPL, Financial). You will barely be able to afford five of them based on the current price of $117. And $240,000 worth of invested capital in the stock market will not even get you one share of Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), which currently trades at $245,330. However, it could get you several of the company’s Class B shares, which currently trade at about $163 a share.
Therefore, depending on your starting capital, you might as well find yourself sifting through the market in search of stocks that cost a few dollars or even penny stocks. However, be mindful of market manipulators in these categories because low prices also create room for manipulation and sharp spikes in the stock price during major company announcements. Either way, you must dig deep in your attempts to obtain information regarding these types of highly uncovered stocks.
There are platforms that specialize in profiling small-cap stocks where investors can get free stock alerts. But even then, chances are by the time you act on such information, it might be too late. Seasoned investors know when to and when not to act on certain potential trading opportunities. As a new investor, it could be hard to tell the right time to act.
This means that as first time investor, the small and highly uncovered stocks might not be the best for you.
What kind of stock should you be looking for?
Most advisors tend to direct their clients towards choosing a defensive stock as their first investment. After all, no one wants their client to lose their first investment on a whim. It could scare them away. So that is a good place to start, but it is not conclusive.
The best way to look at it is the ability to repay your investment over time. A defensive stock may not necessarily be able to do that unless it pays a good dividend on a consistent basis. A high-yielding stock in terms of capital gains, on the other hand, could take a tumble shortly after investing because, as the rule of investing goes, high returns tend to come from high-risk stocks, as per the famous permutation of risk-return trade-off. Nonetheless, some seem to be questioning the reality of this belief.
Therefore, as a new investor, the first thing to look at is a company that has been consistently paying dividends at an acceptable yield (at least 3%) coupled with a continuous growth in dividend paid (of about 3% to 5%) annually. Investors should also ensure that the payout ratio is within the recommended levels (not more than 70%). This indicates that there is room for more dividend growth and that the company is using funds from operations for the payments. Some companies tend to pay high dividend yields but when you look at the payout, you find it is well beyond 100%. That is potentially a high-risk stock to invest in if you are eyeing the dividends.
In terms of pricing, it is best to target a company with a price-earnings ratio that is in line with that of the industry because a low P/E ratio may indicate undervaluation. However, there could be some reasons that are beyond your comprehension that make the stock to appear cheaper.
On the other hand, a high P/E ratio compared to the industry average indicates that investors could be betting on certain products that could improve the performance of the company. That involves taking the risk that the company will perform much better in a few months or years' time. As a beginner buying your first stock, this may not be an ideal thing to do.
Instead, look at the company’s past, the management, annual performances, market share, leading products and major risks to the company’s top and bottom lines. If these look as great as other items, then you have found your stock. If you can buy at least 10 shares of the stock, then you are good to join the market.
Alternatively, why not try an IPO? But that topic is for another day.
Disclosure: I have no position in any stock mentioned in this article.
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