If you're like most young professionals, you've been diligently adding a portion of your paycheck to a savings account, and now you're ready to direct that stash into the stock market for higher rates of return. How do you decide which stocks fit your investment style and are the most likely to increase the size of your portfolio? Luckily, you don't have to choose blindly. There are certain characteristics that will help you determine which companies have been rewarding investors the most and which ones have lagged.
To separate the winners from the losers, you're going to have to pull out that dusty calculator from your calculus days. Find out how a stock has performed over a period of time, such as year to date or month to date, and compare the returns or losses to other companies trading in the same sector. You can find this information on major financial websites. If a company's stock price is outperforming its peers, chances are there's a good reason for it, such as a superior product or better growth prospects. Conversely, if a company lags behind its peers, it might be struggling in some key area. Additionally, you can view a stock's 52-week high and low prices and determine which companies are nearing their best levels in a year and which ones aren't.
Show Me the Value
Compare a company's price-to-earnings ratio to that of its peers to find the strongest and weakest stocks. A P/E ratio illustrates the way investors perceive a stock based on earnings -- past performance or future estimates -- relative to that company's stock price. Companies within a sector with the highest P/E ratios are the ones investors are most willing to bet will reward investors with greater profits. Conversely, investors aren't as hopeful that companies with low P/E ratios in a particular sector will reward investors with a rising stock price.
Dividends R Us
There are certain sectors of the economy, such as utilities and healthcare, that are known for paying dividends to shareholders. These are quarterly cash payments distributed to investors by dividend-paying companies. A dividend yield represents the size of a dividend payment relative to a stock price, and is expressed as a percentage. Companies that pay the highest yields in a particular sector are usually the most attractive. Nonetheless, compare the cash flows of these companies because that's where dividends derive from. A company with a shrinking cash flow may not be able to sustain its dividend in the future.
If you know how to keep up with trends in fashion or culture, apply that same logic to investing. Companies that are the best positioned to capitalize on trends in a given sector -- or that have some key advantage, such as being the first to enter a new market -- could become the strongest stocks in a sector. For example, a pharmaceutical company that is close to developing a breakthrough cancer drug before its competitors is poised to become one of the strongest sector performers. At the same time, a company that keeps losing market share to rivals might be poised to become one of the weaker performers in its sector.
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