How to choose stocks to invest in
Learn how to choose stocks to invest in by understanding risk tolerance, fundamentals, valuation, and diversification to build a thoughtful investment strategy.
Share
In this Article
Share
This content is for general educational purposes and is not intended as financial, legal, investment, or tax advice and should not be relied on as such. We do not guarantee the accuracy or completeness of the information found in this post.
Summary
Choosing stocks starts with knowing your financial goals, risk tolerance, and time frame, not with trying to find the “best stocks.”
You can look at a company’s fundamentals, like earnings per share, cash flow, and its balance sheet, to understand how it makes and uses money, while remembering that strong numbers don’t remove risk.
You can use diversification, index funds, and exchange-traded funds (ETFs) to avoid relying on a single stock, but broad funds and baskets still move up and down with the stock market.
Market volatility, changes in interest rate levels, fees, and your own investing style all affect stock prices and your investment portfolio, so any stock investing plan needs ongoing attention and risk management.
Picking stocks as a first-time investor can be intimidating. Many beginners worry about making a mistake, buying at the wrong share price, or missing some hidden risk. Don’t worry! Stock investing takes time to learn, and no one picks winners all the time. Here, we’ll walk you through choosing stocks to invest in, step by step, so you can make the most thoughtful investment decisions for yourself.
Remember, all stock market investing involves risk, market volatility, and the possibility of losing money. This article is informational only and not personal investment advice.
Start with your goals and risk tolerance
Before you look at any individual stocks, it can help to start with you. Your financial goals and risk tolerance shape what kind of investing style might fit you.
Financial goals describe what you want your money to do. Examples include:
Saving for a long-term growth goal like retirement.
Working toward a big purchase, such as a home down payment, in the future.
Building general wealth over time to support your personal finance plans.
Investment goals and investment objectives add details like how many years you plan to invest and how much risk you feel comfortable taking. You should also consider how much money you’re willing to put into investments, especially if you have little money to invest.
Risk tolerance is your comfort level with losses and price swings. The U.S. Securities and Exchange Commission describes risk tolerance as both your emotional and financial ability to handle risk, and notes that short-term goals often call for less risky assets than long-term investing plans.
Clear goals can help you pick an investment strategy that fits your life instead of chasing random pieces of advice you find on the internet. However, you may realize that some popular types of stocks, or certain types of investment, don’t align with your comfort level. This is not necessarily a good or bad thing, just something to know as you begin your investing journey.
Decide how single stocks fit into your bigger picture
Picking stocks, also called stock picking, means choosing specific companies to own rather than only buying broad funds. Single stock investing can feel interesting, but it also concentrates your risk.
Other options include:
Exchange-traded funds, or ETFs, which are funds that trade like a stock and often hold many stocks inside them.
A mutual fund, which pools money from many investors and buys a basket of securities, such as stocks or bonds.
Mutual funds, index funds, and ETFs can help investors get diversification, but these investments still move with the stock market and involve fees. Funds can build a more diversified portfolio quickly, which can reduce the impact of any one stock’s poor results. However, funds add another layer of fees, and you give up some control compared to choosing each individual stock yourself.
It helps to see single stock choices as just one type of investment in a wider set of investment options, each with different risks, costs, and accessibility.
Know the main types of stocks
Not all stocks act the same way. Understanding the main types of stocks can help you match them to your own preferences.
Common categories you might see include:
Growth stocks: Companies that aim for fast revenue or earnings growth. These often reinvest profits instead of paying dividends. They may offer long-term growth potential, but their stock prices can show large fluctuations, especially when expectations change.
Value stocks: Companies that trade at lower valuations based on metrics like the price-to-earnings ratio. They may look “cheap” compared to earnings or assets. Sometimes they improve and deliver gains, but sometimes they stay weak if the underlying business struggles.
Dividend stocks: Companies that pay a regular cash payout, called a dividend, to shareholders. People often look at the dividend yield, which is the annual dividend divided by the share price. Dividends can provide income, but companies can cut or stop them during tough times.
Blue chip stocks: Large, established companies with long histories and strong reputations. They often appear in major indexes and may show more stable cash flow, but their price per share can still fall and face business risks.
A potential benefit of knowing different types of stocks is you can match types to your investing style and time frame more thoughtfully.
Learn the basics of fundamentals
Fundamentals are the core financial and business facts about a company. Looking at fundamentals helps you understand how a company earns money, spends money, and manages its resources. This process is called fundamental analysis.
Key pieces include:
Earnings per share, often shortened to EPS. EPS is the company’s profit divided by the number of shares. It shows how much profit the company makes for each share you might own.
Cash flow, which shows how cash moves into and out of the business. Healthy cash flow can support operations, debt payments, and potential dividends. Weak or negative cash flow over long periods can signal stress.
Balance sheet, which is a financial statement that shows what the company owns (assets), what it owes (liabilities), and the difference (equity). A very high amount of debt on the balance sheet can increase risk, especially when interest rate levels rise.
By studying fundamentals, you can base your view on real business data instead of only hype or stock prices. On the other hand, good fundamentals don’t guarantee that stock prices will rise. Markets may stay pessimistic, or new problems can appear later.
Understand valuation and common metrics
Valuation is the process of thinking about what a stock might be worth compared to what you pay. Many investors look at valuation metrics to compare companies.
Some widely used metrics include:
P/E ratio, or price-to-earnings ratio. This is the share price divided by earnings per share. A high P/E can signal that investors expect strong growth, while a low P/E can suggest lower expectations or possible undervaluation.
Other valuation ratios, such as price-to-sales or price-to-book, which compare share price to different business figures.
Metrics can help you compare different stocks and avoid paying far more than a company’s earnings seem to support. However, a cheap-looking valuation can reflect real problems that keep the stock weak, and an expensive-looking valuation can stay high for a long time if the company keeps growing. Metrics don’t predict future performance on their own.
Valuation works better as part of a full picture that includes fundamentals, business quality, and risk factors.
Recognize market volatility and price movements
Stock prices do not move in a straight line. They move with market volatility, which is the amount and speed of price changes.
You might see:
Daily price fluctuations from news, earnings reports, or overall market mood.
Drops linked to changes in interest rate policy, economic data, or global events.
Longer cycles where some sectors or types of stocks, like growth stocks or value stocks, lead or lag for years.
The SEC notes that all stocks involve risk and that diversification can reduce but not remove the impact of volatility. By accepting volatility, you stay more patient and less reactive when you know short-term swings are normal. However, volatility can still feel stressful, and if you need to sell during a downturn, you might lock in a loss.
Understanding that fluctuations are part of stock investing can help you think in terms of long-term investing, while also respecting that long-term growth is never guaranteed.
Balance individual stocks with funds for diversification
Diversification means spreading your money across different investments so that one stock or one type of investment does not decide your entire outcome. This can include:
Holding a mix of individual stocks in different sectors.
Using index funds or ETFs that own many stocks.
Mixing stock-based products with other asset classes, such as bonds or cash, based on your risk tolerance and financial planning needs.
Combining individual stocks with broad funds may give you both targeted exposure and general market coverage. But as you add more holdings, you may face more complexity, more providers, and more transaction costs to track.
All examples of mixes here are for educational purposes only and don’t represent advice about what you should own.
Think about your investing style and time frame
Investing style describes how you like to approach the stock market. Some people focus on long-term investing, while others feel drawn to faster activity like day trading.
Long-term investing usually means holding stocks or funds for many years, based on your goals and patience. Day trading means buying and selling within very short periods, sometimes in one day, to try to profit from small moves. Many regulators and educational sites warn that frequent trading and day trading carry high risk, higher transaction costs, and emotional stress, and they note that many people lose money with this approach.
A long-term focus often reduces the pressure to react to each small move. However, you still need to monitor your investment portfolio over time and adjust when your financial goals or risk tolerance change.
Factor in fees, taxes, and other costs
When you pick stocks or funds, it helps to remember that costs reduce your results.
Costs can include:
Trading commissions or spreads when you trade stocks, even if listed commissions are low-cost or zero in some accounts.
Expense ratios in mutual funds or ETFs, which cover fund-level investment management and operations.
Taxes on dividends from dividend stocks and on capital gains when you sell at a higher price than you paid.
Even small fees can add up over time, but you can compare fund costs using tools and fund documents. By paying attention to costs, you can pick from providers and products with a fee level that matches your needs and helps you avoid unnecessary charges. However, focusing only on fees may cause you to ignore other important factors, like risk, service, or whether a given type of investment fits your goals.
Again, any examples of fee levels or products here are general and for education only.
Remember that crypto and stocks differ
While this article focuses on how to choose stocks, many people also hear about crypto assets. Crypto involves digital tokens and blockchains and usually trades in markets that are less regulated and more speculative than traditional securities such as stocks and mutual funds.
Stock investing and crypto are different:
Stocks represent ownership in businesses and sit inside a long-standing regulatory framework.
Crypto assets live on blockchains and often face more uncertain rules and higher volatility.
The Commodity Futures Trading Commission (CFTC) highlights these differences and the additional risks in crypto markets.
Put everything into a clear, cautious process
Because “how to” posts about investing can feel like instructions, it’s important to stress again that this article is educational only. Still, it can help to see a general, non-personal process for thinking about stock choosing:
Clarify your financial goals, time frame, and risk tolerance.
Decide what role individual stocks play versus funds in your overall investment portfolio.
Study fundamentals like earnings per share, cash flow, and the balance sheet.
Look at valuation metrics, such as the P/E ratio and other ratios, with an understanding of their limits.
Think about diversification and asset allocation across different types of stocks and funds.
Consider costs, including trading costs and ongoing fund fees.
Review your choices regularly as your financial planning needs and life situation change.
Every step here is for illustration only. None of them promise results, and none of them replace personalized guidance from a licensed professional if you choose to seek it.
Frequently Asked Questions
Many beginners find it helpful to start with education about how the stock market works, then focus on their own financial goals and risk tolerance before they look at any specific company. Learning about diversification and basic metrics like earnings per share and the P/E ratio can also help.
Individual stocks offer more control and the chance to focus on specific companies, while mutual funds, index funds, and ETFs can provide broader diversification in a single product. Each type of investment has its own risk, cost, and accessibility profile, and no choice is right for everyone.
Many investors review earnings per share, cash flow, and the balance sheet to understand how a company earns and uses money. They may also look at revenue trends, profit margins, and debt levels. These numbers help form a picture but don’t guarantee how stock prices will move.
The P/E ratio compares a stock’s share price to its earnings per share. A higher P/E can mean the market expects stronger growth, while a lower P/E can signal lower expectations or possible undervaluation. It’s one metric among many and works best when you compare similar types of stocks.
Market volatility can cause sudden gains or losses in short-term periods, even when fundamentals look stable. If you pick a single stock or a small group, volatility can feel stronger than in a more diversified portfolio. Understanding your own tolerance for these swings is part of risk management.
Dividend stocks and growth stocks both carry risk. Dividend stocks can provide income, but companies can cut dividends and see their prices fall. Growth stocks may offer higher long-term growth potential but can show sharper price drops when expectations change. Neither type is automatically safer.
Day trading, which means buying and selling over very short periods, often involves high risk, high emotional pressure, and frequent transaction costs. Many educational and regulator resources highlight that frequent trading can lead to losses, especially for beginners.
There’s no exact number that fits everyone. Some investors use a mix of individual stocks and funds to build diversification. Others rely mainly on broad funds. What matters more is how your holdings work together across sectors and regions, not just the count.
Changes in interest rate policy can influence borrowing costs, company profits, and how investors compare stocks to bonds or savings products. Rising rates can create pressure on some stock valuations, while falling rates can support prices. The effect varies by sector and company.