Learn Some Basic Terminology
Most people are aware of a stock's price. Investors and analysts talk about a company's price going up or down on the market in a given day. However, out of context, a stock price gives very little information about the health or value of a company. To truly understand how well a stock is doing, you need to look at a variety of factors. For that, we need some definitions.
Outstanding Shares - This refers to the total number of shares of a company held by all its investors. This number is used to calculate other key metrics like Earnings Per Share and Price to Earnings ratio.
Dividends - Once a company reaches a certain level of stability and profitability, it can choose to start paying dividends. During a growth period, profits are usually reinvested in a company so it can grow more (which also benefits investors), but once growth stabilizes, a company can choose to pay dividends to shareholders. Shareholders can then choose to reinvest those dividends to get even more shares of stock.
Earnings Per Share - This is the amount of money that a company earns per share of stock. It's calculated as a company's net income minus dividends on preferred stock divided by the average outstanding shares. So, if a company makes $50m and there are 18 million shares outstanding, then one share is worth $2.78 worth of the company's income.
Market Capitalization - Market cap is the current share price multiplied by all outstanding shares. This gives you a general idea of the size of a company. While getting the absolute value of a company is a bit more complicated than just looking at the market cap, for most basic research, comparing two company's market cap can help you get a better sense of scale than a share price will.
Price to Earnings Ratio - Put simply, price to earnings (or "P/E") is a company's current share price divided by its EPS. This amount will show you about what investors are willing to pay per dollar of earnings. It can also be used as a metric to determine how much a company is over or undervalued.
How to Pick a Company (or Companies, If You're Smart)
Okay, so now you're at least a little bit more prepared to handle the flurry of financial words that are flying at you. That still doesn't help you decide on a company to invest in, though. What should you even be looking for?
When you're choosing which stocks to invest in, most strategies can fall into one of two categories (and an ideal investor will have both in their portfolio): growth stocks and dividend stocks.
Growth Stocks:
The basic idea behind a growth stock is that you want to buy it when it's not worth much and then sell it when it's worth a lot ("buy low, sell high"). Chances are these are the types of stocks you've heard people discuss when talking about buying or selling a stock because they're the most interesting and see the most change on a daily, quarterly, or yearly basis. As eHow puts it:
A growth stock investment strategy attempts to find companies that are already experiencing high growth and are expected to continue to do so into the foreseeable future. To investors eager to capitalize on this momentum, rapid growth means a fast and sustained increase in the stock price, which leads to a faster accumulation of wealth.
In general, growth stocks aren't a bad idea. If you had invested in, say, Netflix (NFLX) around this time in 2009, you would have seen a 660% increase in your investment. Putting in $100 back then would leave you with $660 now. Not bad for doing nothing for three years (and that's including a large dip in 2011-2012 following the whole price increase/Qwikster ordeal, but we'll come back to that). This is what investors hope for when choosing growth stocks: companies that have room to expand, grow, and provide a return on their investment solely based on the value of the company.
Growth stocks can also be among the most volatile. When you hear about someone losing all their money playing the stock m