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Adam Ritt
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Director of Communications at BetterInvesting (www.betterinvesting.org), a nonprofit dedicated to investment education. Our focus is on long-term investing in growth stocks using fundamental analysis. Companies are mentioned for educational purposes only. No investment recommendations are intended.
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BetterInvesting
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  • This Time It's Never Different: The Time-Tested Tenets Of Fundamental Investing

    With U.S. stock markets reaching all-time highs and valuations reaching 10-year highs in April 2015, enthusiasm for common stocks has returned to an extent few anticipated during the financial crisis.

    During these times it's most important for Main Street investors to remember simple, common-sense rules that have served long-term investors well over the decades. Babson Capital's Brad Perry, in his classic book Winning the Investment Marathon, wrote that investing "is pursued most successfully in a simple, straightforward way."

    It all comes down to this: Buy stocks of high-quality companies at good prices and continue holding them as long as the companies' performance merits doing so. Determine a company's quality by looking at historical sales and earnings growth, potential sales and earnings growth, and key management metrics. These are the roots of fundamental analysis.

    The individual investors and clubs belonging to BetterInvesting, a nonprofit educational association founded in 1951, identify appropriate investment candidates by employing fundamental analysis that focuses on a company's growth. This is because the typical person who has limited time to evaluate stocks can spot a good growth company quickly.

    Value investing, as practiced by Warren Buffett and his mentor Benjamin Graham, is another time-tested method involving fundamental analysis that has served many investors well. But the work required to spot a good value stock is somewhat complex.

    (A sound growth strategy, however, also involves evaluating value, and vice versa. As Buffett says, growth and value investing are "joined at the hip.")

    No matter what the stock market is experiencing, the tenets of fundamental investing don't change. The three most important ideas when evaluating stocks have always been management, management, management. Individual investors should ask two questions when studying a stock:

    • Is this a well-managed company?
    • Is its stock reasonably priced?

    We seek great management because talented, capable executives know how to ensure their company thrives over the long term amid competitive battles and periodic downturns. These are the people, in other words, who are responsible for driving the sales and growth increases that fuel stock prices.

    In assessing management, we don't know everything about a company's day-to-day operations and boardroom discussions. But as laid out in a methodology promoted by association co-founder George Nicholson, we do have a lot of the information we need. A first step in finding a well-managed company is to look at the history of sales and earnings growth. An important indicator of strong management is its ability to grow the business in good times and bad.

    We also seek companies that are growing sales and earnings over the long term at a rate that's high relative to their size. We want smaller companies to have higher growth rates partly because they generally are riskier investments than large companies. The higher growth rate compensates us for this additional risk, and if we do a good job of assessing these companies, we'll see handsome returns.

    Finally, we favor consistent growth over the long term. Consistent performance reassures us about the capability of management. And although the past is no guarantee of future performance (as they say in the mutual fund world), history informs our decisions regarding future growth.

    Two other tests help us assess the company's management. First, we check the company's profitability before taxes and other charges outside of management's control. We like to see stable or growing profit margins. The other ratio is return on equity - how well management is using the equity invested in the company. Again, stable or growing ROE is preferred. Comparing the company's growth rates, profitability and ROE with those of its peers helps determine whether this is a company built for a long voyage or is simply benefiting from the rising tide for its industry.

    Once we've determined that the company in question is likely a high-quality one worth studying further, we need to determine whether the stock is selling at a reasonable price. This involves asking several questions:

    · How high can the stock go?

    · How low can it go?

    · Based on the current price and the stock price's expected range, what is the potential return?

    BetterInvesting members aim for our stock holdings to return 15 percent annually on average over the next five years, or a doubling of return. That's an aggressive target, but the idea isn't to be disappointed if we fail to meet it. It's to maintain our focus on seeking high-quality growth stocks. Achieving annual returns of, say, 10 percent is quite commendable.

    Investors can manage their risk in picking individual stocks by following some simple rules:

    • Require that the company have at least five years of financial history. Younger firms haven't developed enough of a track record for assessing management performance.
    • Study only companies that have proven they can make money. Someone who invests in a company that has never reported earnings is speculating, not investing.
    • Understand the possible risk and reward of owning a stock.
    • Diversify your portfolio. Even if you've done your homework on every holding using all the information you need to make an informed decision, you'll still make mistakes. If you have a good-size basket of stocks, however, you'll also have some stocks that perform much better than expected.

    Besides investing in high-quality growth stocks and diversifying your portfolio, two other simple principles can help you build wealth over the long term. First, reinvest all your dividends and earnings. Second, invest regularly in both good markets and bad; this is often called dollar-cost averaging.

    From time to time Wall Street analysts and other experts attempt to rewrite the rules of investing. During an extended bull market - like the one we're experiencing - some variation of the phrase "this time it's different" usually is invoked, meaning that it's time to forget the simple, common-sense rules of sound long-term investing. Keep the foregoing concepts in mind, however, and you'll be well on your way to a lifetime of successful investing.

    Apr 28 10:42 AM | Link | Comment!
  • For S&P's Stovall, Market Rebound a Three-Stage Process
    I spoke recently with Sam Stovall, chief investment strategist at Standard & Poor's and the author of the Seven Rules of Wall Street, about the current market, which after a strong run beginning in March 2009 paused earlier this year before starting its run again (recent worries notwithstanding). The typical bull market rebound, he says, has three stages: recovery, retest, resumption. If the market pattern continues, we'll have seen a fairly typical recovery and retest already, with resumption the final stage. BetterInvesting members, who continued accumulating high-quality stocks such as IBM throughout 2009, should be in great position to benefit. By June, when Stovall will speak in St. Louis at the BetterInvesting National Convention, we'll likely know whether there was nothing new under the sun about this recovery.



    Disclosure: Long-term holder of IBM
    Apr 28 5:09 PM | Link | Comment!
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