One of the ways to ensure that your portfolio has staying power for the long haul is to use fundamental analysis as you choose investments. The fundamentals of an investment are the basics underpinning that investment. They are items that don’t rely entirely on what is happening in the markets. These fundamentals are the items that prove the value of the investment on its own merit.
When you invest in something that is fundamentally sound, you choose an asset that is likely to have staying power. Yes, a down market will affect even the soundest of assets. However, if an investment is fundamentally sound, it is more likely to recover and help your portfolio; a down market or a down economy won’t destroy the value of the investment.
Here are 4 tips that can help you as you look for fundamentally sound stock investments:
1. Consider Ratios
When choosing stocks, consider the various ratios used to indicate how a stock compares. It’s not about share price; in fact, share price really isn’t all that important when taken alone. Instead, you want to know about how the price compares to the value of the company. One common ratio often is used is the price to earnings ratio, or P/E. Earnings per share is another helpful ratio. You can also use a company’s debt to income ratio to determine the risk of financial problems down the road.
Compare these ratios to the ratios of other stocks, and make comparisons. Choose stocks that show more favorable ratios, indicating good value.
2. Look at Company Management
Do you feel comfortable with the way the company is managed? A well-managed company often shows growth, good profit margins, and a solid balance sheet with good cash flow. Consider whether or not the company has prospered under the current management, and whether the company cultivates a culture that allows smooth transfer of power to another generation of good managers.
Look for indications that CEOs might be taking on too much risk, or receiving outrageous compensation that may not be warranted. Also, look at general practices. Consider regulatory actions, as well as scandals and public relations debacles. While all companies are likely to have seen some bad press at some point, you want to try to avoid companies whose recurring problems put its stock price at risk continually.
Carefully consider management, and how you think it will benefit the company (and hopefully the stock) in the future. This “big picture” item can make a big difference down the road.
3. Use a Stock Screener to Help You Narrow Down Your Options
Stock screeners can help you identify possible investments that fit your parameters. There are a number of free stock screeners out there, with a variety of factors that you can enter to help you find just what you are looking for. Choose a stock screener that allows you to consider various ratios, as well as market cap sizes, and other factors. Once you have a few likely prospects, you can delve a little bit deeper into the stocks to choose which are most likely to make the best additions to your portfolio.
A stock screener can help you avoid information paralysis, as well as let you know what’s available in the first place. A stock screener can help you identify solid additions to your portfolio that you would never have thought about on your own.
4. Consider ETFs
Finally, don’t discount ETFs. An ETF is a low-cost type of fund that trades like a stock on an exchange. If you aren’t certain about choosing a fundamentally sound individual stock, consider looking for an ETF that has a number of stocks. An index ETF or some other ETF that focuses on a sector that is fundamentally sound can provide you with a way to begin investing for the long-term good of your portfolio without some of the pitfalls that come with picking individual stocks.
As you become more comfortable with identifying fundamentally sound investments, you’ll feel more confidence as you create a portfolio that will grow wealth for the long haul.