Warren Buffet, one of the greatest investors of our time, said ‘never invest in a business you don’t understand. This is one of the golden rules of investing and the very first of a few gems on how to choose a stock to invest in.

Stock investing can be a great way to increase wealth and hedge against inflation but to succeed, you need to pick the right set of companies to invest in. However, choosing the right option for you can be a daunting task, especially with the variety of options currently in the market. Here are tips to consider when choosing:

1. Never invest in a business you don’t understand: A good way to pick stocks is choosing from companies with easy-to-understand business models that produce everyday services and products that you personally experience. If it’s difficult to understand how the company works, it’s best to let it be.
2. Avoid emotion when choosing investments: Do not invest blindly in stocks because there’s hype around it or because you are afraid of missing out, also do not rush into any buying or selling decisions.
3. Spread your risk by diversifying your portfolio: Diversification is important for your investment strategy. Spread your risk by holding a mix of shares and bonds across a range of industries, companies, and countries. Diversification is necessary because if one particular investment performs poorly, it will not ruin the overall performance of your portfolio, so your risk is reduced.
4. Watch out for value traps: value traps refer to when companies’ figures look undervalued relative to their sector peers and their shares look like a good deal but are suffering financial distress. There’s always the risk that the company looks undervalued because it is doing poorly and has low growth potential. To avoid value traps, always consider a company’s qualitative factors, such as its competitive advantage and management effectiveness.
5. Check insider activity: Management of the company buying shares is a strong indication of confidence. Insiders are always more likely to know what the best valuation for their company truly is. It’s a good step for you to pick stocks where the management team has a strong stake in its future performance.
6. Understand financial ratios: Companies make public financial disclosures which consist of three main documents – the balance sheet, profit-and loss-statement, and the cash flow statement. You can calculate several financial ratios that give insight into how the company is managed, its financial stability, and whether it’s profitable. These fundamental analysis ratios should be compared between different years and between peers in the same industry.

 READ ALSO: How to Use Financial Ratio to Measure Stock Performance

Recently, you’ve been hearing a lot about a certain stock, and for some reason, you begin to feel a FOMO (fear of missing out) – which happens to most investors since we all are looking to maximize profit anyways. But how can you determine if a stock is doing well and it’s ok to buy? The answer: research the company.

How do you research a company or stock performance? Periodically, public companies disclose their financials to the public. These financial statements consist of three main documents – the balance sheet, profit-and loss-statement, and the cash flow statement.

Investors analyze how these companies are managed, their financial stability, and whether they are profitable or not by calculating several financial ratios. You may have come across any of these ratios and wondered what they mean. Let’s dive into a brief explanation of the 8 financial ratios used to analyze companies and their stock performance.

1. Price-to-earnings (P/E) ratio: P/E ratio assists in comparing the value of one stock in a sector with another, it measures a stock’s value by showing you how much you would have to spend to make $1 in profit. It’s a guide to determine if a company is currently overvalued or undervalued compared with its historical growth.
2. Debt-equity ratio (D/E): This measures a company’s debt against its assets and gives insight into how the company is performing relative to its competitors. A low ratio could mean that the company gets most of its funding from its shareholders. A ‘good’ or ‘bad’ ratio depends on the industry.
3. Return on equity (ROE): this shows you if a company is generating enough income by itself relative to the amount of shareholder investment. It measures a company’s profitability against its equity, expressed as a percentage.
4. Earnings yield: this measures earnings by dividing the most recent 12-month earnings per share by the current market price per share. The earnings yield (the inverse of the P/E ratio) represents a company’s earnings per share as a percentage. When calculating earnings yield, a company’s growth prospects are critical. Stocks with high growth potential are typically valued higher, and their earnings yield may be low even as their stock price rises.
5. Relative dividend yield: This measures a company’s dividend yield compared to that of the entire index. If you’re looking to buy stock, you should consider the relative dividend yield because it can show if stocks are overvalued or undervalued compared to competitor stocks
6. Current ratio: this is a liquidity ratio that measures a company’s ability to pay off debts within a year by comparing a company’s current assets to its current liabilities. It shows if liabilities can be adequately covered by the available assets. The lower the current ratio, the higher the likelihood that the stock price will continue to go down.
7. Price-earnings to growth (PEG) ratio: this is a measure of the P/E ratio compared to the percentage growth in annual EPS. If you are deciding on which stocks to pick, you should consider the PEG ratio because it could give you an indication of the stock’s fair value
8. Price-to-book (P/B) ratio: this is a measure of the current market price against a company’s book value. A ratio higher than one often indicates overvalued shares.

As you progress on your investment journey, it is important to hold the best cards to ensure your portfolio is balanced and you earn well as an investor (investor vibes). Not only is investing a great way to earn passive income but you are making essential money moves by not leaving your savings in a bank account to wallow and depreciate.

Of all the very many classifications of stocks, these four are important types to own to protect you from the inevitable waves of the market. Whether you are new to investing, an OG or somewhere in between, a balanced portfolio is good for the pocket so here are four types of stocks that every savvy investor should own:

1. Growth stocks

These types of shares are bought for the growth of your capital, irrespective of the dividends they pay and these are bought from a company with high growth potential. These are usually found in industries that capitalise on consumer trends and therefore see sales and profits rise quickly.

Growth stocks are shares in companies that are generating positive cash flows and whose earnings are expected to grow at an above-average rate relative to the market. Investing in growth stock carries greater risk as competition between similar companies can be fierce and even a slight slow in growth can reduce investor confidence leading to a reduction in share prices.

For the best growth stocks, be sure to research successful businesses that tap into strong and rising demand among customers, especially in connection with longer-term trends that support the use of their products and services.

2. Dividend stocks

Dividend stocks also called yield stocks are those that pay a certain income periodically. The amount paid will depend on how many shares you own. Dividend stocks are a type of passive income and one of the most popular types of stocks that people invest in due to the money that constantly trickles in. When looking for which stocks pay dividends, look for yield and look for stability in the core business. Many stocks make dividend payments to their shareholders regularly.

3. Cyclical Stocks

As you have no doubt noticed, the economy of Nigeria is on a proper rollercoaster, I mean an amusement park standard. National economies sometimes display a cycle of prosperity and recession, expansion and contraction. Some businesses are more affected by this cycle than others. These are companies that depend on economic prosperity to flourish such as tourism, travel, luxury goods and manufacturing. They have highs and lows and investors, therefore, refer to them as cyclical stocks.

Economic downturns can reduce the ability of customers to make major purchases quickly but when there’s an economic high (bull markets), investors rush these companies causing them to regain their profit margin quickly, this makes these stocks good to have in your portfolio.

The Monetary Policy Committee (MPC) held its 5th meeting of 2022 on the 26th and 27th of September. The committee members voted unanimously to raise the key interest rate.

Key decisions:

• – Increase the Monetary Policy Rate (MPR) from 14.00% to 15.50%.
• – Retain the asymmetric corridor at +100/–700 basis points around the MPR.
• – Increase the Credit Reserve Ratio (CRR) to 32.5% from 27.5%
• – Retain Liquidity Ratio at 30.0%.

Likely Impact of Interest Rate Hike

Impact on Customers: Negative and Positive

Higher borrowing cost due to the pass-through effect of higher interest rates. On the other hand, bank customers might see higher savings rate in the bank.

Impact on Inflation: Mild

We are of the opinion that the MPC’s decision might have little impact on taming the burgeoning inflation as adverse supply-side shock continues to fuel inflationary pressure.

Impact on the equities market: Negative

The equities market is expected to become less attractive due to the expected increase in yields in the fixed income in the coming months. The direction of yields in the fixed income market has an inverse relationship with the equities market.

Impact on the fixed income market: Positive

The fixed income market will likely be more attractive, especially at the long end of the yield curve.  

Impact on foreign capital flow: Mild

On foreign capital flow, we expect little foreign investor participation due to FX repatriation and exchange rate issues.

Impact on Banks: Negative and Positive

Banks stand to benefit from the higher interest rate environment. However, due to the increase in the cash reserve ratio to 32.5%, banks’ liquidity might come under more pressure.