To find the best stocks to buy, you need to know how to spot undervalued stocks. These are stocks you can hold over the long term as part of a buy-and-hold strategy, confident in the knowledge that they can weather the ups and downs of market swings.
Beyond buy-and-hold investing, there are other ways to make money in the stock market. You can make money trading stocks in one of three ways:
- When you buy a stock and the share price rises
- When you short a stock and the share price falls
- When the stock pays a dividend
But how do you find the best stocks to buy that are likely to rise in value or the most overvalued stocks that are likely to fall in value? And how do you find dividend paying stocks that can regularly put money in your pocket even if the share price doesn’t rise much?
Stocks To Buy Now
The best stocks to buy are undervalued and have a high likelihood of rising. To find undervalued stocks, use a fair value calculator to easily see how much upside or downside share price potential exists.
To find the best stocks to buy now, you need to identify the stocks with the greatest upside potential. The best stocks to buy for the long term are undervalued stocks. But how do you find these undervalued stocks?
On Wall Street, research analysts build discounted cash flow models and other valuation models to identify what a company is worth. They build spreadsheet financial models that project what companies will earn over time, and calculate the present value of those payment streams.
Hedge funds and investment management firms also rely on teams of investment analysts to build financial models in order to accurately forecast how much money a company will make over time. If the market capitalization of a company is below the estimated valuation they calculate, the company is considered to be undervalued, and if the market capitalization is above the valuation, the company is overvalued.
As a regular investor, you don’t have the luxury of time, even if you had the inclination, to build financial models for all the stocks in the S&P 500, New York Stock Exchange, and Russell 2,000. But you can easily identify a fair value estimate for a company by using this stock value calculator.
Simply enter a stock symbol, and the computer algorithms crunch through the data in the financial statements to arrive at a fair value estimate for a company. You can quickly compare the fair value estimate to the price target calculated by Wall Street analysts, as well as the current stock price. Plus, you can easily see how much upside or downside share price opportunity exists.
Best Penny Stocks
Penny stocks are cheap to buy but low share prices do not necessarily mean company valuations are low. Sometimes the most expensive stocks to buy have the lowest valuations and the cheapest stocks to buy are the most overvalued.
A mistake casual investors sometimes make is to buy or sell based on a current stock quote. It is easy to get swept up in the momentum of a rising share price and make an emotional decision to purchase. Fear of missing is out on future gains motivates irrational buying that pays no heed to whether a company is undervalued or overvalued. Similarly, panic selling often stems from fear of a stock spiraling lower, even though a quick valuation check might suggest the stock is undervalued.
Share price and valuation are distinct, but low share prices attract casual investors in search of a bargain. Penny stocks are especially alluring because for just a few thousand dollars a buyer can potentially own tens of thousands of shares. The opportunity to make a quick buck is enticing and the volatility of penny stocks lends itself to big share price gains – and losses!
Penny stocks traded on the OTC or over-the-counter market. They are often early stage businesses that have not proven out their business models yet. Some will go on to feature on major exchanges while others will falter and fail. Because of the challenges figuring out how to separate the wheat from the chaff, penny stocks are generally deemed appropriate for sophisticated investors.
If you are looking for the best penny stocks to buy, you can use the research tools available at one of the best penny stock brokers. You can often read research reports from equity analysts at independent research firms to help you decide whether a penny stock has the potential to soar higher or plummet lower.
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If you are looking to buy-and-hold for the long term, comparing the current market capitalization of a company to its estimated valuation is perhaps the best place to begin.
It is tempting to look at a share price, like the one below, and make an investment decision based on whether the share price has been rising or falling recently. It is equally easy to conflate a high share price with a high valuation or a low share price with a low valuation.
As obvious as it sounds, just because a share price is high (like Google’s historically has been) doesn’t mean the company is overvalued and just because a penny stock has a low share price doesn’t mean the company is undervalued.
Shorting A Stock
Short selling is a way of making money when share prices fall. To short stock, a margin account is required that lets you borrow and sell shares, which are later purchased. The difference between the price the shares were initially sold at and subsequently purchased at is the gain (or loss) you pocket when you short the market.
Shorting a stock is a less conventional but very effective way of making money in the stock market when share prices fall. To short stock, you will need to open a margin account. Established brokers, such as TastyWorks, allow you to open a margin account and short trade stock.
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HOW TO SHORT STOCK
The way to short stock is you borrow the stock you want to bet against and instantly sell those shares. When the share price falls, you can buy to cover your position – which means you close out the short stock position. The shares you borrowed are returned to your brokerage and you keep the difference (or lose the difference if the share price rises).
SHORTING A STOCK: HOW TO FIND OVERVALUED STOCKS
Before shorting a stock, you should pay special attention to the risks of short selling. When you buy a stock, the most you can lose is what you pay. But when you short a stock, the most you can lose is not defined. You could potentially lose more than you own because theoretically the stock can keep rising in price. If you do decide the rewards of short selling are worth the risks, then finding good short stock candidates begins by identifying overvalued stocks.
To find good short selling opportunities, screen for stocks that are overvalued. If your broker does not have a screener to help you easily spot overvalued stocks, this screening tool can help you to sort through stocks that may be trading above fair value.
A word of caution on short selling comes from a John Maynard Keynes quote, which states:
“The market can stay irrational longer than you can stay solvent”
The point of the investing quote is that while you might think a stock or the stock market is overvalued, and rationally you might be right, the market can keep rising longer than you imagine possible. So, if you are going to short stock, define your risks clearly and stop losses if necessary.
Best Dividend Stocks
The best dividend stocks have solid fundamentals, pay a good dividend in good times and bad, and regularly increase the dividend paid to shareholders.
In Stocks For the Long Run, Professor Jeremy Siegel shares a statistic that is startling to most investors: 95% of the total stock market return between 1926 and 2008 is attributable to reinvested dividends.
While casual traders look to buy stocks low and sell them high to make money, Professor Siegel highlights how important dividend paying stocks are to increasing your nest-egg over time.
To find the best dividend stocks, the place to begin is usually with old stalworth companies that are long established and have a record of paying dividends in good times and bad. Coca Cola is one of the best dividend paying stocks; it is known for its longevity and success whether the economy is strong or weak because of its global diversification, broad customer base and extensive distribution network. Other stocks that pay dividends and have stood the test of time include blue chip stocks, such as General Electric and Exxon.
Dividend stocks that have higher yields should be approached with some caution. Sometimes, a company paying a high dividend yield is doing so because the share price has declined due to some fundamental cause. It is generally not a good idea to buy a stock only for its dividend; it should be fundamentally sound too. After all, you don’t want to lose in share price more than you make in the dividend. High dividend stocks may not remain so if the company decides to cut the dividend.
With that said, some high dividend stocks are a bargain. When valuation is low and dividend yield is high, the opportunity to make money from a rising share price as well a a high dividend exists.
You can easily spot some of the highest dividend paying stocks here:
>> Learn How To Diversify Your Portfolio Intelligently
>> What Are The Best Penny Stock Brokers
>> Consider Passive Investing With Robo-Advisors:
If researching high yield stocks doesn’t whet your appetite, a hands-off investing service provided by robo-advisor firms may fit your investing needs better. Among the best robo-advisors is Betterment, which will invest your funds automatically, rebalance your portfolio regularly, harvest tax-losses to boost after tax returns and diversify your portfolio across numerous asset classes.
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