Understand how to research stocks by using financial ratios and advice from successful investors to get strong investment returns

Many people try to learn about investing by gathering up loads of information. But knowing how to research stocks also involves absorbing and organizing your information so you recognize and remember the essential aspects of it.

Learning about investing doesn’t come without setbacks, but you can limit your risk with these tips.

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 Here’s how to research stocks for safer and more profitable investing

 Stock investing for beginners can be much more profitable when you know how to research stocks and discover tips that will help you cut risk and increase profits in your stock market portfolio. We’ve long recommended these tips:

• Look beyond financial indicators.
• Think like a portfolio manager.
• Research U.S. stocks and seek to hold a reasonable portion of your portfolio in them.
• Update your research and knowledge—but give your investments time to pay off.

How to research stocks: Understand debt-to-market cap so you can determine the true value of a company

The debt/equity ratio is one way to assess a company’s financial condition. The conventional idea used to be that a debt/equity ratio should be less than 1.0; this is, debt should be less than equity. But the conventional definition of equity only includes capital invested in a company, plus earnings that were retained in the business rather than paid out.

For many companies today, this is not a particularly accurate way to look at things. That’s because the company’s main value is in assets that it built out of a tiny asset base. In cases like this, it may make more sense to compare a company’s debt to its market capitalization or “market cap”—the value of all stock it has outstanding.

Market cap tells you what the market thinks a company is worth. It often makes a lot more sense that the equity value that appears on the company’s books.

Learn how to research stocks by using price-to-sales ratios as one of several tools

Price-to-sales (p/s) is the ratio you get when you compare a stock’s price to its sales per share (you get sales per share by dividing total annual sales by the number of outstanding shares).

The basic stock research rule is that a high p/s tends to mean that a stock is expensive, and a low p/s tends to mean that a stock is cheap. However, many individual stocks seem to run counter to this rule. Stocks with deservedly high p/s ratios can rise for lengthy periods, and stocks with deservedly low p/s ratios can fall.

That’s why it’s important to keep price-to-sales ratios in perspective in your stock research. They tend to provide hints rather than clear answers.

Watch for a price-to-sales ratio that can signal potential future gains for investors

Sales are the raw material of earnings; that is, sales minus expenses equals earnings, so earnings are always less than sales.

So, if a stock has a very high p/s ratio—30, say—its price-to-earnings (or p/e) ratio has to exceed 30, since “e” has to be less than “s”. In that case, it needs very high sales growth rates if it is ever to earn enough profit to justify its current stock price, let alone go higher.

On the other hand, suppose your stock research uncovers a company with an extraordinarily low price-to-sales ratio, such as .01 (for example, a $1 stock with $100 a share in sales). That can indicate a lot of capital-gains potential, if the company can improve its profit margin.

However, if a company can’t make money then a low p/s is no advantage. In fact, it usually signals danger, rather than a bargain. Money-losing companies eventually go out of business.

Find low-price, high-quality stocks to add to your portfolio for stability and profits

Virtually all successful investors have some form of a value investing strategy, at least for a portion of their portfolio.

At the same time, many successful investors also have some knowledge of technical analysis, and most have some knowledge of a variety of other tools and shortcuts.

But almost all successful investors take a broad view, and apply everything they know to their investing decisions.

When you look for stocks that are undervalued, it’s best to focus on shares of quality companies that have a consistent history of sales and earnings, as well as a strong hold on a growing clientele. Furthermore, we recommend using a few more basic ratios.

• Low price-to-earnings may be a sign of a cheap or undervalued investment.
• Low price-to-book-value ratio is another sign that a stock is cheap in relation to other stocks on the market.
• Dividend yield is the stock’s annual dividend divided by the share price. A high dividend yield could indicate a cheap stock that is set to rise.

Learn about investing through studying the qualities of successful investors

If you ask investors who have a few decades of successful investing behind them, few, if any, will credit their success to any one investment or investing technique. Instead, most will talk about the value of everyday qualities like patience, consistency and a healthy sense of skepticism—in short, the kind of qualities that bring success in all aspects of life, not just investing. 

Use our three-part Successful Investor approach to make investment decisions that will bring quality stocks into your portfolio

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

What is your most treasured resource for stock research?