If you’re just getting started with investing in stocks, you might be somewhat daunted by all that you have to learn. It takes a lot of work to buy individual stocks, but you do have some shortcuts available that can help you bypass investments that are more likely to be losers and stick to stocks that can outperform the market over time.
Here are the best stocks for beginners and what you should watch out for as you start investing.
Best stocks for beginners: What to look for
As investors begin to explore the market, these are some of the best stocks to look for. Stocks in these areas are not all good buys, but they’re a great place to start your search for attractive returns. You’ll need to do research and spend a lot of time educating yourself if you want to invest in individual stocks — it’s not quite as simple as picking a few stocks and hoping that you get lucky.
Blue chip stocks
Blue chip stocks are those that have the strongest resources and operate in the best industries. They may be known as “the” company in an important industry such as software or finance.
If you’re a new investor on the hunt for great stocks, one of the first things to understand is that you don’t have to find a hidden gem to make plenty of money. In fact, many of the market’s best stocks deliver outstanding results even after they’ve become household names. For example, Amazon was already well-known a decade ago, but it has still delivered fantastic returns since then.
Blue chips are generally considered to be the best of the best, and include the stocks in the Dow Jones Industrial Average as well as the largest stocks in the Standard & Poor’s 500 index and the Nasdaq Composite.
Companies with growing sales and profits
The market rewards companies that are growing their sales and profits – and generally, the faster, the better. The quicker a company can grow, the higher the stock price can go. While a stock may do anything in the short term, these factors drive the stock over the long term.
New investors can look at a company’s growth over the last five to 10 years. Companies able to grow sales and profits at, say, more than 8 or 10 percent annually for a long period have strong businesses that can likely continue to grow at attractive rates. For example, Apple has been a solid growth stock for a couple of decades, even if there have been lulls along the way.
The past is no guarantee, of course, that the future will be bright, but it’s a great place to begin your research.
Firms sporting strong balance sheets
When a company goes bankrupt, its stock usually ends up worthless or close enough that it’s not worth arguing about. What’s the easiest way to avoid investing in a company that will go bankrupt? Stay away from those with significant debt and stick to those with lots of cash.
It’s difficult for companies with a lot of cash – and those continuing to generate plenty more of it (see above) – to go out of business. While cash-rich companies may experience difficulties in a recession, they can end up thriving on the other side. In contrast, tough times may be much tougher for high-debt companies, which may be hamstrung by their debt. They may need to take on more expensive debt to continue operating, rendering them unable to invest in their business.
Cash-rich companies such as Berkshire Hathaway regularly have tons of money in their hands and a demonstrated record of investing in their businesses to keep them growing.
Dividend stocks
Companies with a history of paying cash dividends to their shareholders are another great place to begin. These dividend stocks are generally backed by businesses that are strong enough to sustain the payouts, and the best companies grow their dividend every year, too.
Some of the best dividend stocks have been paying and growing their dividend for decades. One exclusive group of dividend stocks is called the Dividend Aristocrats, which includes companies that have paid and raised their dividend for 25 years or more.
Dividends can form a significant part of investors’ returns each year, and finding companies that have a strong record of payouts is a great place to start.
Stocks to watch out for as a new investor
Good investing is not all about buying the best stocks. In fact, avoiding specific types of stocks can help you steer clear of investments that have a low chance – even virtually no chance – of working out well. As legendary investor Warren Buffett has famously said: “The stock market is a no-called-strike game. You don’t have to swing at everything — you can wait for your pitch.”
Below are the types of stocks that new investors should be more cautious about. Sure, these stocks might work out fine in time, especially if you’re an advanced investor and know what you’re doing. But the types of stocks below present a lot of extra risk for new investors:
- Small caps: Small-capitalization stocks, or small caps, are smaller companies, with a total value of their outstanding stock up to about $2 billion or so. Many great companies began as small caps and then grew into mid-caps and large-caps. But they’re riskier because the business is less established and the companies themselves generally don’t have the same financial resources as larger companies. Rather than buy individual small caps, however, the best small-cap ETFs can get you in the game with lower risk.
- OTC stocks: Stocks on the over-the-counter (OTC) exchanges tend to be smaller and, more importantly, have lower disclosure requirements than those on large exchanges such as the New York Stock Exchange and the Nasdaq. While many well-regarded foreign companies also trade OTC, it runs rampant with small American companies of dubious standing. It’s true that you can find some overlooked gems here, but you’re going to need good investing skills to make sure that you’re not the one getting fleeced.
- Penny stocks: Penny stocks – usually defined as those trading for less than $5 a share – are another place to avoid entirely, and many will trade OTC, so you’re already cutting many out by avoiding that area. Penny stocks may not provide the same financial disclosures as larger stocks, and they may also be subject to manipulation due to their small size. Again, if you know what you’re doing, you may find a hidden gem here, but for newer investors, it’s a good idea to simply take a pass on this area.
- Stocks from a message board or a so-called tipsheet: There is no shortage of people offering a “hot tip” on a stock, and many of them may lurk on message boards or offer “research” promising huge returns if you buy the stock they tout. In many cases, these offerings are “pump-and-dump” scams trying to lure in new investors with big promises to run up a stock’s price so that scammers can offload the stock at a higher price.
These areas of the stock market tend to be riskier than investing in well-established companies, ranging from “somewhat riskier” to “you’ll be lucky to get out with any money.”
Consider stock index funds
While it can certainly be fun and exciting to invest in individual stocks, new investors can do quite well by buying a high-quality stock index fund and don’t ultimately need to buy individual equities to earn satisfactory returns. In fact, buying an index fund such as one based on the Standard and Poor’s 500 index (the S&P 500) ends up beating most investors – even the pros – over time. It’s a great place for beginning investors to start their investing journey.
The S&P 500 index consists of hundreds of America’s top companies – strong blue-chip firms that have thrived for years – and it has an enviable record of delivering about 10 percent annual returns over long periods of time. These companies generally operate in strong industries, have deep financial resources and often pay out attractive and growing dividends.
One great aspect of an S&P 500 index fund is that you don’t really need to do the analysis that is required for investing in individual stocks. The fund offers diversification, and it’s perfect for a buy-and-hold investor looking to not spend a whole lot of time and energy on investing.
Even if you’d like to invest in individual stocks, an S&P 500 index fund makes a great core holding for any investor, beginner to advanced. Then as you gain more experience and confidence in your investing process, you can add individual stocks or other investments.
Bottom line
The best stocks for beginners are often stocks that are household names already, with established businesses and financial strength. By sticking with proven companies and avoiding specific riskier areas of the stock market, new investors can likely be more successful early on.
— Bankrate’s Brian Baker contributed to an update of this story.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
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