How Do I Find Stocks to Invest In?


Ask SmallIvy

Dear SmallIvy,

My question is how to really find stocks. I figure I should be able to watch 6-8 stocks pretty closely and get to know them well enough to make decisions. Where do I really start? Am I better off finding the best performing sector/industry and researching the top stocks of the bunch or start to look at some bruised sectors/industries?

Thanks for your time and your blog!

Mike

Dear Mike,

The two strategies you are describing are the main investing strategies that are employed by seasoned investors, momentum investing and value investing. 

When you find the current Hot sector and find the hottest stocks in that sector, you are momentum investing.  This is effectively “buying high” and “selling higher.” This form of investing, also known as “the Castles in the Clouds” approach, can be successful if you are skilled at figuring out what the current hot trends are, get in early enough to make a profit, and then get out before the sector turns cold.   The danger is that if you are too late, you may be left holding the bag when the momentum stalls and the stocks in that sector begin to drop.  See https://smallivy.wordpress.com/2010/04/10/firm-foundations-and-castles-in-the-clouds-part-2-castles-in-the-cloud/ .

The second approach in the value investor, or “Firm Foundation” approach.  This is “buying low” and “selling medium.”  The idea here is to find good stocks, those that have a “firm foundation,” but that are out of favor currently.  One determines what the fair market value should be for the stock using PE ratio, predicted earnings, current dividends, and other measures.  One then buys the stocks that are currently trading at the greatest discount to the fair market value.  The idea is that the stocks will eventually trade at their fair value. 

This approach offers little danger of suffering a large loss because the stocks one is buying are already beaten down, but it takes great patience because it often takes a long time for stocks to be rediscovered and move upwards.  One must also be careful because some stocks are out-of-favor for a reason.  One is certainly more in danger of buying stocks that will go out-of-business when bottom fishing.  For more information on this strategy, see https://smallivy.wordpress.com/2010/04/02/firm-foundations-and-castles-in-the-clouds-part-1-firm-foundation/ .

Both of the above strategies can and do work and have been used successfully by various legendary investors.

I tend to do a hybrid of the two strategies.  I look for stocks that have long-term earnings growth, that are leaders in their sectors, and have plenty of room left to grow.  (For some of the specific factors to consider, see the Stock Picking category of this blog: https://smallivy.wordpress.com/category/stock-picking/ ). 

I am looking for long-term momentum – stocks that have been going up for years and there is nothing in the fundamentals of the business that will prevent them from continuing to go up.  I then use predictions of future earnings to predict future prices (3-5 years out) and determine which stocks in my list of growth stocks is best priced at the time I am investing.  I will continue doing this each time I have some money to invest. 

These types of stocks tend to be in industries like restaurants, retail, insurance,  and technology.  The reason is that these are sectors where companies start small and then have room to grow by copying the model.  If you open a restaurant and are successful, you can open another one across town, then across the state, then across the nation.  These also tend to be younger companies.

As far as where to find these stocks, one of the best ways to find these stocks is to flip through a set of stock charts looking for stocks that have slow, steady increases in price.  As an example, see the chart for AFLAC: http://finance.yahoo.com/q/bc?s=AFL&t=my&l=on&z=l&q=c&c= .  Except for the dip during the market crash, one could almost lay a ruler across the stock  price.  It is steadily increasing, but not so fast so as to be unsustainable.  If you look at earnings for the stock, you’ll also note that earnings have been growing steadily as well, which is why the stock has been increasing.

Unfortunately the internet does not make “flipping through stock charts” easy.  Good old paper is the way to go still.  One of the best resources I know of is the Value Line Investment Survey.   It is costly ($800 per year), but it provides a vast wealth of information on each company, provides stock screening (including a proprietary momentum screen called Timeliness), and even gives a one-page write-up on each company. 

My rule is that any investing subscription should pay for itself, which Value Line does.  It is worth getting a subscription when you’ve built up a large portfolio, but you can usually get access for free at libraries.  If you’re investing long-term, you really won’t trade that often, so it may be just as easy to visit the library every few months on a Saturday morning to develop a list of stocks using Value Line.  You can then buy the pick from your list that seems to have the best value each time you have some cash to invest.

To ask a question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Comments appreciated! What are your thoughts? Questions?

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