I got an email from reader Brad who asked:
I wanted to suggest a post that goes into some more detail about your thought process as you decide whether or not a stock is a good investment and how you use that info to identify reasonable targets and expectations for performance. Is it based on financial data? Common sense? SEC filings?
As a novice trying to get into the mindset of a more experienced investor, that would be very helpful.
Thanks for the question Brad and I hope you are not disappointed with my answer. There isn’t a magic formula and there isn’t a secret filter or analysis system I use to weed out the best stocks.
Things I Like In A Stock
1) A dividend – I always prefer a stock with a dividend because at least you are making money while you wait for the stock to go up. Or you lose less if the stock goes down. Especially now, with interest rates at historically low levels, a stock with a dividend looks even better than it might if interest rates were higher. So, I am more inclined to buy a stock if it has a dividend.
2) A low P/E – To really see if a stock’s P/E is low you need to compare it to all its competitors. If you are looking at a stock that has a P/E of 40 and all the other similar companies have a P/E of 20, then the stock is probably expensive. That doesn’t mean the stock won’t go up. It just means there must be a reason why investors are willing to pay more for that company than the others. Paying more for a company is riskier than paying less and I prefer to pay less whenever possible. But many high flyers (Amazon, FB, etc.) have huge P/E’s and have made investors a lot of money so there is no right or wrong here.
3) The company has a business that will allow me to own the stock for at least 1 year – I don’t always stick by this rule and have already broken it twice in the portfolio for this website (CHL and YHOO). However, in an ideal situation I like stocks I can buy and hold and the longer the time period, the better. That means I look for companies that have products or services that will stand up to competition and I can confidently own their stock for an extended period of time. I’m not a trader even though buying and selling stocks frequently seems to be the fad now days. I’m an investor, a long term investor.
So, What Do I Do And What Am I Thinking During The Stock Picking Process?
I think the above quote from Warren Buffet can make you and I a lot of money. I wish I had more time and patience to do what he says because THAT is a great way to think about and pick stocks. Remember, when you buy a stock you are buying the company and the business they are in. Some companies are better than others and some businesses are better to be in than others as well.
I pay as much attention to current events as possible. Simply put, the more information you have in your head, the better you should be at many things and that includes investing. The stock market is all about picking the companies that are going to lead us into the future successfully. If you can pick the right industries and the right companies within them, you will undoubtedly make money.
Right now technology as a whole is hot but within the technology sector there are still winners and losers. Its that way in every industry: some companies just perform better, have better management, and plan for the future better than others. Picking the winners can be done by reading, research, listening to other people’s opinions, and ultimately making a decision yourself which stocks to buy. Again the more information you consume every day and the more you are aware of what is going on around you, the better stock investor you will become.
I Think Common Sense Is Very Important
Brad briefly mentions common sense and yes, I think that is vital. You need it in all aspects of investing because remember, it is your hard earned money you are risking when you buy stocks. You, and you alone, must figure out how much money to allocate to each stock and what types of stocks to buy: risky, not risky, or somewhere in between. Additionally, only you can decide at what price you are willing to buy a stock and after that comes another difficult decision of when to sell the stock.
There are decisions to be made every step of the way and common sense, at least your version of common sense is important!
You have to feel comfortable with the decisions you make. I always say that sleeping well at night is a personal priority to me. That means I may be a more conservative investor than someone else is but that is okay. Every person has to get used to what they are comfortable with in regards to risk and that may influence many of their stock investing decisions.
Buying Stocks Of Companies You Like
You might be able to get started looking for good stocks by thinking about all the companies and brands you like to use. Of course the brands you like may not be good stocks but it is a good place to begin. If you like certain brands then perhaps other people like them as well and you should check out their stock.
Here is an example: I have a couple of Under Armour (UA) shirts that I absolutely love. Back in May 2014 I looked at their stock for the first time after seeing more and more people wearing the logo. The stock was in the $45 to $50 range and on a 2 month downtrend. The P/E was also more than double that of Nike’s so I held off, hoping the price would come down some more and then I would buy. Unfortunately, about a week later the price shot up into the $50’s and now the stock is about $70 a share. I missed out and never bought and I HATE that.
But the point is that I picked a winning stock just by paying attention to what I liked and what I saw that other people have started liking. Being aware of everything that is going on around you can really pay off. Again, you should try to become aware of what clothes people wear, what and where they eat, how they spend their free time, what they buy, etc. so that you can better figure out what stocks may be profitable.
I hope that helps everyone who is trying to get a better understanding of what is going though my mind and what I do when I’m looking for stocks to buy. I’m always interested in finding the next stock in my portfolio!