Finance and Career

Beginner’s Guide To Stock Investing: How To Find Low Risk Stocks

As a beginner to stock investing, you want to start out with very simple and low-risk stock picks.   These stock picks aren’t necessarily 10-baggers (1,000% return on your investment) but they mitigate the risk of losing (too much) money.  These are stocks that will, for the most part, follow the market.  As a beginning stock investor, I feel that it is extremely important to start out with low risk stocks so you can get a feel of how the stock market reacts to certain news, numbers, and rumors.  Here are several important metrics you need to look at in order to find a low risk stock as a beginner to stock investing.

Earnings Per Share (EPS) of over \$2

EPS stands for earnings-per-share.  This number is calculated by taking the profit of a company and dividing by the amount of shares outstanding.  In its simplest form, here is what the formula actually looks like:

EPS= NET PROFIT / Average Shares Outstanding

For instance, if a company’s annual profit is \$100,000 (after paying its preferred shareholders) and it has an average of 50,000 outstanding shares of common stocks, then the EPS (earnings per share) is \$2.

This number is calculated for you when you look up stock quotes.  You want to look for a stock that has an EPS of at least a somewhat decent return on their investments.  If the EPS is negative (or lack thereof) for a quote you are looking up, that means the company is losing money, which will reflect badly on their stock prices.  I find that an EPS of at least \$2 is a good safety net.

Beta around 1

Beta is the number that tells you how volatile the pricing for the company is.  The lower the beta is, the lower the volatility for the stock price.  Technically the stock market has a whole has a beta that is pegged to 1.  So any number that has a better over 1 is more volatile than the market and a beta of less than 1 is less volatile than the market.  But just because a stock has a beta of one does not automatically make it a risky stock—it just means the price is currently fluctuating more than the current market average.  If you are a beginner in stock investing, I would not recommend picking a stock with a beta over 2, as it the price fluctuations can be too much for some to take.

Average Volume of at least 1 million shares

Average volume is the average daily shares traded in the stock market for a certain stock.  Trade can mean either bought or sold.  We want to ideally look for average volume of at least 1 million.  The risk we run of picking a stock with low average volume is volatility in prices.  The low number of shares traded makes the price more sensitive to price movement.  It is basic supply and demand.  You don’t want too many buyers or sellers.  Having high volume insures that there aren’t too many of either—and that there is enough buyers or sellers to balance each other out.

P/E Ratio

The P/E ratio is calculated using the following formula:

Price Per Share / Earnings per Share (EPS) = P/E

If a stock is priced at \$20 per share and its Earnings Per Share is \$2, then it’s P/E ratio is 10.  The P/E ratio ultimately tells us how much investors are willing to pay for \$1 in the company’s earnings.  In our example above, the P/E ratio is 10—so it means that investors are willing to pay \$10 for every \$1 of earnings.  In general, a high P/E means that investors are expecting higher earnings and growth in the future compared to companies with a lower P/E.  However, a high P/E ratio can also mean that a stock is overpriced.  For example, if you have a P/E ratio of 30, that means a shareholder is willing to pay \$30 for every \$1 of earnings.  But in the end, the P/E ratio is extremely relative to each industry segment.  A “good” P/E ratio of a technology company may be higher than a “good” P/E ratio of a gas company.  For example, the P/E ratio of BP hovers around 5-6 whereas the P/E of Google and Apple are currently 21 and 17 respectively.  So before investing in a company, do research on their industry and find out what a “good” P/E ratio for that industry is.

Market Capitalization over \$500 million

Market cap is simply how much the company is worth, on wall street at least.  Market capitalization is calculated by taking its outstanding shares and multiplying it by its stock price. The larger the market cap, the more it is worth, and therefore the more stable it is.  \$500 million is a good number because it doesn’t eliminate good growing companies but it is big enough to eliminate small volatile ones.

This is just a guideline for those who are just getting started with stock investing.  Use these metrics as just a guide and not a rule to abide by.  Good investing requires decisions based on qualitative analysis but it also requires independent thinking outside the numbers.  So use the above metrics to get you started but once you are more experienced, set your own rules for stock investing.