I was asked this question on Quora.com. Here's the answer I provided:
I assume you mean the purchase of individual companies, rather than a Mutual Fund or Exchange Traded Fund (ETF). The strategies are different. I’ll explain what I look out for when buying stock in a company.
- Do I understand the business? I tend to invest in telecommunications, information technology and/or energy stocks because I understand these markets.
- Is the company earning money? Are earnings growing? What are the prospects for the future (though this is sometimes just guessing)?
- Are revenues increasing? Does the company offer a service or product(s) that will be used for years to come?
- Is the company financially sound? Does it manage its debt well? Does it have a sound Return on Equity? A company with too much debt or doesn’t invest its earnings well will not have a sound future.
- Is the stock priced fairly? I don’t want to buy a company when the stock price is already inflated. I use technical analysis to attempt to determine the best time to buy. I’m patient and willing to wait until the price is low enough. This is called value investing. For example, I’m not going to pay $35 a share for AT&T. I’ll wait until its under $30. Same goes for Caterpillar. I didn’t buy when it was $135–140. I waited until it was $115. I thought that was a better price. No guarantees, but my odds of making money are better.
These are just some of the basics. There are some good books on this subject, but probably the one every serious investor reads is The Intelligent Investor by Benjamin Graham. I also really like One Up On Wall Street by Peter Lynch. While written many years ago, the principles in these books still apply.