There comes a point in many investors' lives when they decide to dabble in the stock market. I consider this to be a turning point in the life of an investor, a coming of age in which one graduates from a passive strategy and demands more control over their investments. Some people return to managed investments shortly after trying their hand at stocks because of a bad experience, while others have success and maintain permanent involvement with their investment decisions. Besides the potential for profitability, researching your own stocks has derivative benefits as well. First, your understanding of individual corporations and the economy in general will likely improve. Also, your journey into stocks may inspire a curiosity about other areas of the investment arena such as bonds and real estate.
I remember back in college when I first took an interest in the stock market. I dedicated a chunk of my spare time to examining financial statements, listening to quarterly earnings reports and researching executives to find out who’s who. On the topic of research, it should be noted that the Google finance portal launched in early 2006 and is a must see for new investors. While many loyalists still prefer the Yahoo portal, Google Finance has truly unique features such as interactive charting and a search tool specifically designed to navigate the blogosphere. I remember when the market dabbling phase happened in my own family many years ago. My father installed a satellite dish on the roof of his dental office to give him improved access to stock quotes. Each time his stocks went up the computer would make a sound like a cash register. Each time they moved down you’d hear something of a train wreck. Ah yes, those were the days of dabbling. So, how should you go about picking stocks?
There are practically as many theories about how to pick stocks as there are stocks to invest in, so the first thing you need to do is determine an investment strategy which is right for you. Will you be the sort of investor who buys a stock for life? I respect this strategy but believe few people have the patience or desire to follow it. The opposite end of the spectrum includes day traders, who pick up stocks in the morning with the hope of gaining a few percentage points and selling the company that afternoon. I’d like to focus in on the value-oriented investment approach for a moment since this seems to be hailed by some of the most famous money managers including the master himself, Mr. Warren Buffet. Value investing entails finding companies with deflated stock prices which you sense could be undervalued by the market. There are numerous ratios which value investors will use to view their stocks against others in either the same sector of the market or some other benchmark comparison.
One such example is P/E (price to earnings) which is a valuation ratio of a company's current share price compared to its per-share earnings. A low P/E ratio may indicate that a stock is cheap relative to its peers. Of course, there may be some other factor (such as a pending lawsuit) which can justify the low P/E ratio. Because of certain complexities in the stock picking process, some investors shy away from self-picking stocks and simply follow an established approach to investing. One such example is the Dogs of the Dow. There are variations to this strategy but let me to explain the basic concept: an investor picks the ten stocks out of the thirty in the Dow Jones Industrial Average with the highest dividend payouts and lowest prices. Dividends, for the record, are company profits which are paid out to shareholders. At the end of each calendar year, you redesign the portfolio using the new, lowest price stocks in the Dow. Utilizing the Dogs of the Dow strategy would have given you an average annual return of 13.46% over the ten year period ended December 31st, 2005 (Dogs of The Dow Annual return based on 10 dogs as of December 31, 2005). Please note that no strategy can assure success and past performance does not guarantee future results.
Before we continue I should make two things clear about the workings of the stock market:
• The stock market is exactly that: a market. When an overall lack of confidence pervades the market and feelings of uncertainty about the future exist, stocks can go down. You may even find a stock going down on a day in which the company announced good news. This sort of anomaly should not make you angry or even surprise you. It’s a part of the emotional roller coaster that comes along with following stocks.
• While many theories exist for how to obtain unusually high returns in the stock market, there is no proven method which will always outperform the major market indexes. You may find a theory which works for ten years in a row and then turns on its head the year you decide to try it out. You might complain that it’s just your luck, but many people will share these experiences with you.
One way to narrow down your list of stocks is by using a screener. Perhaps you read in a magazine that you should buy small capitalization stocks with high return on equity percentages. You might have no clue what this means, but you can still follow the advice. Yahoo and MSN both offer stock screening services in the investment research areas of their websites. You can plug in data such as company size, ratios, cash balances, earnings growth, etc. Within seconds, a list of stocks that fit your criteria will appear on the screen. You can then choose your stocks from the updated list.
Another great way to choose stocks is based on common sense. This strategy is rarely discussed in the financial community and I think it’s a good one. In 2004 I went shopping at a gourmet market on Long Island. While examining the expensive and well packaged goods I thought about how impressive this shopping experience was relative to others I’ve had. I also noticed they carried a large supply of health and organic foods; capitalizing on the trend to eat healthy which has blossomed in recent years. This kind of thought process can lead you to a company with real profit potential. The trick is capitalizing on the time lag between when a good idea is created and when it’s recognized in the stock price. It turns out the market I was shopping in was indeed a publicly traded company. Needless to say, the price was lower back then and the company has grown and matured since. The key is taking a position in a stock before positive news items hit the spotlight- certainly easier in theory than in practice. Once everybody else hears about it, you’ve probably reached the time to sell your stock.
My girlfriend provides another interesting strategy for purchasing stocks. At the end of each calendar year, she views her credit card statements and buys stock in those companies in which she spent the most money. At first I laughed at her method, but then I realized the brilliance of such simplicity. As a resident of New York City, she’s exposed to many new and exciting trends before they become nationally recognized. Further, by purchasing her stocks based only on where she shops, she isn’t trying to time the buying of a stock on a day when the price is seemingly low. This works out well since many investors fall into the emotional pattern of buying a stock when its price is high and selling it the second it dips down. Her strategy has led her into some very attractive companies and subsequently, attractive profits as well. One area to watch out for when utilizing this strategy is overcrowding a certain sector, in her case retail. This can be dangerous during economic cycles when certain industries tend to be more resilient than others to fluctuations in consumer spending.
Finally, a great way to research stocks is by reading the advice and experiences of other investors. This can help you avoid some of the otherwise inevitable problems which new investors tend to have. Some of these include:
• holding on to a winning stock for too long (being greedy)
• not knowing when to sell a losing stock (maybe it’ll come back syndrome)
• getting emotional over swings in the price of stock
There are so many great web resources for investors that it’s difficult for me to narrow down the list. You could start your research with a visit to TradingMarkets.This site is made excellent by the knowledge and experience of its contributors, many of which are seasoned financial services professionals. TradingMarkets has a breaking markets news section which updates every sixty seconds with story stocks. They also have a section called themoneyblogs which syndicates a variety of financial blogs onto their website. You can find my blog in there along with many others broken down into categories such as trading, real estate, and personal finance.
If you surf the blogosphere, Seeking Alpha should be on your visit list. Seeking Alpha is different from other sites in that the focus is on opinions rather than news. Rather than journalist coverage, you get primarily the thoughts of investors and financial professionals. In fact, many of the bloggers referenced in this book are also contributors to the Seeking Alpha Network. For those who may not follow financial jargon, alpha, in this context is a reference to how well a portfolio is performing given a certain assumption of risk. Some of SeekingAlpha’s notable features include:
• The ability to search for articles by typing in the ticker symbol or name of the company you wish to learn more about. This user-friendly feature makes the filtering process much easier.
• You can link to blog articles on specific areas of the market such as Biotechnology, Media, Gold, the Internet, and Japan.
• They have a comprehensive listing of earnings conference call transcripts. For the investor who does her homework, this becomes a great resource for figuring out what’s going on behind the scenes each quarter.
While Seeking Alpha is a more of a collective resource in terms of reading opinions, I’d like to point out some individual blogs which I visit as well:
• TickerSense is run by the money management firm Birinyi Associates. The blog combines stock discussion with market analysis and current trends in an easy-to-understand fashion. They also have a subscription newsletter which provides stock picks.
• Controlled Greed focuses on value-oriented investment strategies. Value stocks have prices that appear cheap relative to a few different analysis techniques. The name is a reference to Warren Buffet who said that controlled greed is an important quality for investment success.
• 2d trading is a cool blog for swing traders and short term stock pickers. The blog owner, Edgar Alcidi, is a technical trader who offers charting, daily commentary, and other helpful trading resources (Edgar trades for his own account).
Dabbling in the stock market can be both fun and profitable if you are resourceful and do your homework. Read about the experiences of others and pick an investment strategy which you are comfortable with. Remember to go back and review your strategy and risk tolerance every so often as well. A safe strategy is to make a budget which you dedicate to your dabbling and keep it separate from retirement accounts and other saving vehicles which are essential for your future goals.