How I Pick Stocks

When I look for stocks to buy, I am not looking to make a few bucks over the next day, week, or month.  I’m looking to buy something that I can the forget about.  I don’t have time to be sitting there, watching the intra-day movements for the right time to buy or sell.  I have also found that doing so is no more effective than going to Vegas and trying to make money playing roulette.  The intra-day movements are no more predictable than is the toss of a coin.  You don’t know what other traders are thinking and why they are paying the prices they are paying.  When news comes out it is already too late – the effect is already priced into the stock.  And that “rumor” you heard or tip you got from that business magazine is just someone else’s guess at what will happen, and the very fact that it is printed and thousands of people read it can move the stock price before you have a chance to buy or sell.

I instead rely on good old-fashioned capitalism.  I believe that a business that provides something people need and that is run well will become more valuable over time.  I don’t personally know how to manage a muli-state or international operation, but by buying shares in a company that hires such people, I can benefit from their capabilities.

I therefore invest in stocks the same way that I would invest in a local business.  If there were a pizza place in town that you knew did a steady business but was unlikely to see business grow, you could buy part of the business and expect to see a constant but steady income from the business.  If you found a shop that was doing well and was ready to open up additional restaurants in other areas, you could both get income from current operations and see the value of your share of the business grow.  You see, if you own 10% of one restaurant worth $500,000, you could probably sell it for $50,000 int he future.  If you bought into a business when they had one restaurant, however, and then they opened up nine more restaurants that did equally well, you could sell your stake for $500,000.

You would make money from the income the business receives, called current income, but you would also receive money from the growth of the business, called a capital gain.  Current income is nice if you have bills to pay, but if you can let you investment compound, you can make a lot more from capital gains.  Plus, you normally need to pay taxes on current income as you receive it and there is also an expense to reinvesting.  If you primarily get your income from capital gains, you see your money grow faster without the additional expenses.

So if I were investing in a local business, I would look for one that is expanding and gaining new business, rather than one that has relatively fixed revenues.  I would also not invest and expect to see a big return over the next few months.  It takes time for a business to grow, so I would be ready to wait for several years.  I would also only invest if I thought the business would exist for several years – no point in investing in a fad that will be gone in eight months.

I would also know that things would happen to the economy in general that are beyond my control or ability to predict.  I can’t prevent the Federal Reserve from raising interest rates and causing a recession.  I can’t predict or prevent a terrorist attack in New York that shuts down tourism for a while or a cyber attack that disrupts business.  I can’t know when some politician will make an off-handed comment that causes the market to swoon.  I just know that if I invest in companies that can weather the storm while their competitors go out of business, they will emerge stronger than ever if I am just prepared to wait things out.

So, when I am investing I look for:

1) A good management team.  A history of steady price and earnings growth is a good indicator of this, with officers who have been at the company throughout that steady price growth period.

2) A good product that will be needed for the foreseeable future.  I look for companies that are selling toilet paper, not Beanie Babies.

3) A company that can grow by expanding into new areas or developing new products.  I want companies with just stores in a few markets, not household names that are everywhere.

4) A company that is fairly priced for the potential it has.  Good companies are normally priced above their peers if you look at price-earnings ratio, but I wouldn’t buy a stock that is priced say at 2 to 3 times the PE of its peers.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. 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. Tax advice should be sought from a CPA.  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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