In Level 4 of this course, we provided step-by-step walkthroughs on how to find the best small cap, large cap, dividend, growth, value, and blue-chip stocks.
In this lesson, let’s build on those earlier lessons and cover some good reasons to actually buy a stock from your research.
This list isn’t meant to be exhaustive, but it’s a good place to start when deciding whether or not you should add something to your portfolio.
We’d recommend you run through this entire checklist before buying a stock. The goal is you should be able to say, “Yes”, to all five of the questions below before adding the new stock.
We’ve included a brief “Stock Buyer’s Checklist” handout that summarizes the points below. We recommend you read the full write up below and then download the checklist for your future reference.
Click on the image below to download your copy of the “Stock Buyer’s Checklist”
1) Am I only investing money I won’t need for the next 5-10 years?
As we covered in one of our early lessons, you should never invest money in the stock market that you’ll need to use soon (typically in the next 5-10 years).
The idea is that if there’s a deep market decline, it will almost certainly recover over the next 10 years. But if you need the money you invested for something (say, your children’s education, retirement, or mortgage payments), it may not be there for you while the market is still in decline.
So your the first item on your checklist is really, “Is this money that I’m prepared to invest and leave in the market for the foreseeable future?”
2) Is this the best possible stock for my investment strategy?
In Level 4 of this course, we covered in-depth how to find the best value, growth, small cap, large cap, blue chip, and dividend stocks.
We also talked about the incredible power of combining multiple investment strategies together.
Before buying a stock, you should have a clear and compelling reason as to why you’re buying THIS particular stock. For example:
- Is it the leader in a fast-growing industry?
- Does it offer a strong, steady, and sustainable dividend?
- Is it massively undervalued?
- Is it one of the steadiest stocks on the market?
- Has it delivered 10 years of steady above-average sales and profit growth?
Whatever your investment strategy, having a clear reason or thesis for your purchase makes sure that every new stock is a “conviction buy.”
In addition, you should have done some solid research to make sure the company appears well-positioned to deliver on your thesis. In other words, look closely at all the elements of the company that relate to your investment strategy.
This step is especially important as it also helps you know when to sell your stock.
When you have a crystal clear reason for buying, it’s much easier to see when a stock no longer serves your goals and should be sold.
We’ll cover reasons to sell your stocks in our next lesson.
3) Do I have a good way to follow this stock in the future?
As we discussed at length in our last lesson, we encourage a “buy and homework” approach to investing.
So before you buy a stock, it’s important to make sure you have some way to follow important new developments in that stock in the future.
For example, if you’re buying a high dividend stock to collect steady dividend income, how will you know if they boost, cut, or fail to raise the dividend?
Many investors carve out time each week to “study up” on new developments around their investment portfolio. This is a great hands-on approach, but can take significant time if you own a portfolio of 10-30 stocks.
Other investors rely on outside sources of data, such as financial data providers, investment advisors, or investment newsletters.
Whatever your strategy, remember having a plan for “buy and homework” is an important part of successful long-term investing.
4) Do I have a way to tell if my thesis is playing out correctly?
In question #2 above, you ask what your thesis is for this particular stock.
In question #3, you make sure you have a way to keep tabs on new developments around this stock.
Here in question #4, you ask what future metrics, developments, indicators, or signs will tell you if your investment thesis in this stock is playing out correctly or not.
For example, if you bought General Electric (GE) 10 years ago for its steady dividend, you’d want to regularly check the company’s dividend yield, dividend growth, payout ratio, long-term debt, etc.
If those all continue to look good, you know your thesis is playing out and you can continue to hold.
However, at some point you would’ve seen some of these metrics start to deteriorate, suggesting General Electric was no longer the steady, reliable, high-dividend stock you originally bought. Then you would’ve known it’s time to sell.
This question is about asking yourself, “What should I watch for to know if this stock continues to be a good investment vs. it’s time to sell and find something better?”
5) Have I checked that this stock fits with my overall portfolio?
Finally, you want to make sure your new stock will fit with your overall portfolio.
In our earlier lesson on how to diversify your portfolio, we discussed making sure you weren’t too concentrated in a single industry, sector, size, and more unless you specifically wanted to be.
This final checkpoint is all about ensuring your new stock doesn’t overly concentrate you in some way.
For example, is this the 20th high-dividend utility company you’re adding to your portfolio? Is that too much of a concentrated bet on utility stocks?
Or, are you putting 70% of your funds into this single position, while spreading the other 30% among 10 different stocks? Do you really want to concentrate so much into one stock?
You don’t have to overthink this step, especially if you’ve followed our recommendation to pick stocks based on combining several different investment styles.
The point is simply to take a step back and view this stock in the context of your whole portfolio.
Lesson Summary: When Should You Buy a Stock?
Today we covered a 5-point checklist for buying a new stock.
You should be able to confidently answer, “Yes”, to these five questions before buying something new in your portfolio:
- Am I only investing money I won’t need for the next 5-10 years?
- Is this the best possible stock for my investment strategy?
- Do I have a good way to follow this stock in the future?
- Do I have a way to tell if my thesis is playing out correctly?
- Have I checked that this stock fits with my overall portfolio?
In our next lesson, let’s dig into when you should sell a stock from your portfolio.