Jumping in the Shallow End:
How Do I Find the Stocks I Should Buy?
Planning for one’s financial well being in the future has never been more important. Recent studies have confirmed that Social Security will only cover 40% of expenses of a highly desirable lifestyle in our later years, and with debates swirling in Congress about cutting those benefits, other forms of income are more critical now than ever. After establishing a regular savings and taking an investment class for beginners, you have made the first steps toward financial security. You understand the law of compounding interest and that stocks are good long-term investments. The question now is how to you go about picking stocks for your portfolio.
The general rule of thumb in selecting a stock is that you should only invest in companies that you can understand. Knowledge is the cornerstone of your investing foundation. Research, assisted with a bit of technical analysis, will provide the basis for making intelligent choices. There are a variety of different types of stocks out there, and you should be aware of these and how the stocks within each type react to changing market conditions. Timing is important when making a selection, as are the various methods available for guiding your judgment process.
Stocks come in a Variety of Flavors:
- Growth Stocks: These companies typically grow their revenues at rates that exceed the average of the market. They will also re-invest their earnings in their growth, such that dividend pay outs may not exist. Not all growth companies are good investments since they may be overpriced.
- Cyclical Stocks: The earnings and revenues for these companies are highly sensitive to the business cycles of the economy. When times are good, they outperform, and vice versa. Steel manufacturing, car sales and home building are examples.
- Defensive Stocks: These companies are the opposite of the previous type. They can operate well in an economic downturn. These companies might include food, beverage, drug and utility stocks.
- Income Stocks: These companies tend to be larger, more mature, and pay out a relatively high portion of their earnings in quarterly dividends. Utilities are a good example here.
- Value Stocks: There is such a thing as a bargain stock. Its value may be less that what its fundamentals would suggest, and with growth in place, its ability to appreciate is a good bet in most cases.
- Small Company Stocks: The potential for high return is present, as is a higher risk profile. Small companies can grow faster, but volatility is the norm. Low prices do not mean bargains. These companies tend to have market capitalization's below $1 billion.
- International Stocks: You may need an online forex broker around to guide you in these choices. Knowledge of the forex market is important in evaluating potential impacts on earnings and revenues if conversions to Dollars are critical. Currency fundamentals reflect where industries have a distinct growth advantage due to the national market they serve. The developing markets of the world are presently growing at twice the rate of the developed markets.
If you have decided to purchase shares of individual companies rather than shares of mutual funds or exchange traded funds, then diversification of your portfolio is a must in order to lessen the risk posed by any one or group of companies. Spread your ownership between 20-30 different companies to provide sufficient diversification.
There are also a variety of methods used to select stocks. These may be the top-down approach that seeks to evaluate the present economic cycle and choose accordingly, the bottoms-up approach that starts with specific companies and their financial data, or simply using technical analysis to search for fundamental economic data that suggest that growth and appreciation are imminent. The key objective in each method is to find a company that is growing with a relatively cheap share price.
There are a number of financial measures that can point you in the right direction. The Price-Earnings Ratio, or P/E ratio, is the best know of these and a quick indicator of value for a stock. Learning to interpret this ratio relative to the business cycle, to other stocks in the same industry, and to the market in general is one of the skills that you will want to develop. However, as a beginner, the enormity of information may overwhelm you. The best course to follow at this stage is to rely on other experts. Morningstar and Value Line Investment Survey provide basic stock information and analysis on their websites or at your public library.
Choosing stocks can be a daunting task for the beginning investor, but the process can be both fun and rewarding. Outsource much of the tedious work to the experts, and then learn to profit from your logical approach and selection criteria.