Picking Your Own Stocks -Learn to Earn_ A Beginner’s Guide to the Basics of Investing and Business.
If you have the time and the inclination, you can embark on a thrilling lifetime adventure: picking your own stocks. This is a lot more work than investing in a mutual fund, but you can derive a great deal of satisfaction from picking your own stocks. Over time, perhaps you’ll do better than most of the funds.
Not all your stocks will go up—no stockpicker in history has ever had a 100 percent success rate. Warren Buffett has made mistakes, and Peter Lynch could fill several notebooks with the stories of his. But a few big winners a decade is all you need. If you own ten stocks, and three of them are big winners, they will more than make up for the one or two losers and the six or seven stocks that have done just OK.
If you can manage to find a few triples in your lifetime—stocks that have increased threefold over what you paid for them—you’ll never lack for spending money, no matter how many losers you pick along the way. And once you get the hang of how to follow a company’s progress, you can put more money into the successful companies and reduce your stake in the flops.
You may not triple your money in a stock very often, but you only need a few triples in a lifetime to build up a sizeable fortune. Here’s the math: if you start out with $10,000 and manage to triple it five times, you’ve got $2.4 million, and if you triple it ten times, you’ve got $590 million, and 13 times, you’re the richest person in America.
Actually, there’s nothing to keep you from investing in mutual funds and buying your own stocks as well. Many investors do both. Much of the advice in the mutual fund section—the advantages of starting early, of having a plan, of sticking to the plan and not worrying about crashes and corrections—also applies to the portfolio of stocks you pick on your own. Two problems confront you right away: How do I figure out which stocks to pick? Where do I get the money to buy them? Since it’s dangerous to put money into stocks before you figure out how to pick them, you should put yourself through some practice drills before you risk your cash.
You’d be surprised how many people lose money by investing in stocks before they know the first thing about them! It happens all the time. A person goes through life with no experience in investing, then suddenly receives a lumpsum retirement benefit and throws it all into the stock market, blind, when he or she can’t tell a dividend from a divot. There ought to be some formal training for this, the way they have drivers’ ed in school. We don’t put people on the highway without giving them a few lessons in the parking lot and teaching them the rules of the road.
If nobody else is going to train you, at least you can put yourself through training, trying out various strategies on paper, to begin to get a feel for the way different kinds of stock behave. Again, a young person has an advantage. You have the luxury of experimenting with imaginary investments, at least for a while, because you have many decades ahead of you. By the time you have the money to invest, you’ll be fully prepared to do it for real.
You’ve heard of fantasy baseball, where you pick an imaginary team from the major-league rosters to see how your team’s batting average, home run production, and so forth, measure up against the real teams, or against other fantasy teams? You can train for stocks with a fantasy portfolio. Take an imaginary bankroll—$100,000, perhaps, or $1 million if you’re a big spender— and use it to buy shares in your favorite companies. If, for instance, your five favorite companies are Disney, Nike, Microsoft, Ben & Jerry’s, and Pepsi, you can split $100,000 five ways and invest a mythical $20,000 in each. Choosing April 21, 1995, as your starting date, your fantasy investment lineup looks like this:
Once you’ve chosen your stocks and written down the prices, you can track your gains and losses just as you would if you’d put in hard cash. You can compare your results to the results your parents are getting in their real investments (if they have any), or to the results of various mutual funds, or to other mythical portfolios your friends have made up.
Schools across the country have brought fantasy stockpicking into the classroom, with The Stock Market Game, sponsored and distributed by The Securities Industry Foundation for Economic Education. More than 600,000 students played the game during the 1994/1995 school year.
They divide into teams, and each team has to decide which stocks to buy with its mythical bankroll. The game takes about ten weeks from start to finish. Results are tallied, and the team whose stocks have gone up the most at the end of the period wins the game. The winning teams in each school compete with the winners from other schools in local, county, and regional or state competitions.
Playing The Stock Market Game can be fun as well as educational, as long as the players are taught the basics of investing and don’t take the results too seriously. The problem with this sort of training is that over thirteen weeks, twenty-six weeks, or even a year, what happens to stock prices is largely a matter of luck. The practice sessions don’t last long enough to give you a true test. A stock can be a loser in thirteen weeks, but a big winner in three years, or five years. Or it can be a winner in thirteen weeks but a loser down the road.
Stocks that do well in the long run belong to companies that do well in the long run. The key to successful investing is finding successful companies. To get the most out of your training sessions, you have to do more than follow the prices of the stocks. You have to learn as much as possible about the companies you’ve chosen and what makes them tick.
This brings us to the five basic methods people use to pick a stock. Here’s the rundown on each, beginning with the most ridiculous and ending with the most enlightened.
- The lowest form of stockpicking. You throw a dart at the stock page and wherever it lands, you buy that stock. Or you close your eyes and use your finger as the dart. Maybe you’ll get lucky and your finger will hit on a stock that does well—but maybe you won’t.
The best thing you can say about the dart method is that it doesn’t take much work. If you’re inclined to pick stocks at random, you’ll be doing yourself a favor by avoiding the whole business and investing in mutual funds.
- Hot tips. The second-lowest form of stockpicking, where somebody else tells you to buy a stock that’s a cinch to go up. It could be your best friend, your English teacher, your uncle Harry, the plumber, the auto mechanic, or the gardener. Or maybe you overhear the tip on a bus. For some reason, overhearing a tip gets people more excited than if the tip was meant for them.
It’s possible that Uncle Harry is directly involved with a certain company and knows what he’s talking about. That sort of informed tip can be useful—a clue that’s worth investigating further. But the dangerous kind of hot tip is based on nothing but hot air. Here’s a typical example: “Home Shopping Network. The smart money is accumulating this stock. Buy right away, before it’s too late. It looks like that sucker’s going up.”
People who won’t buy a fifty-dollar toaster oven without checking several stores for the best price will throw thousands of dollars at a hot tip such as “Home Shopping Network.” They do this because they can’t stand to miss out on all the profit they’ll “lose” if they ignore the tip and the Home Shopping stock quadruples. The truth is, if they don’t buy Home Shopping and it quadruples, they haven’t lost a penny.
People never lose money on stocks they don’t own. They only lose money if they buy Home Shopping and it goes down and they sell it for less than they paid for it.
- Educated tips. You get these from experts who appear on TV or are quoted in newspapers and magazines. There’s a constant stream of educated tips flowing out of fund managers, investment advisors, and other Wall Street gurus. You’re not the only person who’s been let in on these educated tips. Millions of readers and listeners are hearing the same thing you are.
The problem with expert tips is that when the expert changes his mind, you have no way of finding that out—unless he goes back on TV to inform the viewers and you happen to catch the show. Otherwise, you’ll be holding on to the stock because you think the expert likes it, long after he’s stopped liking it.
- The broker’s buy list. Stockbrokers of the “full-service” variety are never shy about giving their recommendations on what stocks you should buy. Often, these recommendations do not come from the broker’s own head. They come from the analysts who work behind the scenes at the head office, usually in New York. These are well-trained Sherlocks whose job it is to snoop into the affairs of companies or groups of companies. They issue buy signals and sell signals based on the evidence they dredge up.
The brokerage firm collects the buy signals from its analysts and puts them on a buy list, which is sent out to all the brokers, including yours—if you have a broker. Usually, the buy list is divided into categories: stocks for conservative investors, stocks for aggressive investors, stocks that pay dividends, and so forth.
You can build an excellent portfolio by working with a broker to pick stocks from the buy list. That way, you can rely on the brokerage firm’s research and still get to choose which of the “buys” you like best. This has one big advantage over relying on educated tips. If the brokerage firm changes its mind and moves one of your stocks from the buy list to the sell list, your broker will inform you of the fact. If he doesn’t, then put the broker on your sell list.
- Doing your own research. This is the highest form of stockpicking. You choose the stock because you like the company, and you like the company because you’ve studied it inside and out. Maybe you already did that with your five favorite companies in your fantasy portfolio, as in the example of Disney, Nike, Ben & Jerry’s, Pepsi, and Microsoft shown on page 127.
The more you learn about investing in companies, the less you have to rely on other people’s opinions, and the better you can evaluate other people’s tips. You can decide for yourself what stocks to buy and when to buy them.
You’ll need two kinds of information: the kind you get by keeping your eyes peeled and the kind you get by studying the numbers. The first kind, you can begin to gather every time you walk into a McDonald’s, a Sunglass Hut International, or any other store that’s owned by a publicly traded company. And if you work in the store, so much the better.
You can see for yourself whether the operation is efficient or sloppy, overstaffed or understaffed, well-organized or chaotic. You can gauge the morale of your fellow employees. You get a sense of whether management is reckless or careful with money.
If you’re out front with the customers, you can size up the crowd. Are they lining up at the cash register, or does the place look empty? Are they happy with the merchandise, or do they complain a lot? These little details can tell you a great deal about the quality of the parent company itself. Have you ever seen a messy Gap or an empty McDonald’s? The employees at any of the Gap outlets or the McDonald’s franchises could have noticed long ago how fantastically successful these operations have been and invested their spare cash accordingly.
A store doesn’t have to fall apart to lose customers. It will lose customers when another store comes along that offers better merchandise and better service, for the same prices or lower prices. Employees are among the first to know when a competitor is luring the clients away. There’s nothing to stop them from investing in the competitor.
Even if you don’t have a job in a publicly traded company, you can see what’s going on from the customer angle. Every time you shop in a store, eat a hamburger, or buy new sunglasses, you’re getting valuable input. By browsing around, you can see what’s selling and what isn’t. By watching your friends, you know which computers they’re buying, which brand of soda they’re drinking, which movies they’re watching, whether Reeboks are in or out. These are all important clues that can lead you to the right stocks.
You’d be surprised how many adults fail to follow up on such clues. Millions of people work in industries where they come in daily contact with potential investments and never take advantage of their front-row seat. Doctors know which drug companies make the best drugs, but they don’t always buy the drug stocks. Bankers know which banks are the strongest and have the lowest expenses and make the smartest loans, but they don’t necessarily buy the bank stocks. Store managers and the people who run malls have access to the monthly sales figures, so they know for sure which retailers are selling the most merchandise. But how many mall managers have enriched themselves by investing in specialty retail stocks?
Once you start looking at the world through a stockpicker’s eyes, where everything is a potential investment, you begin to notice the companies that do business with the companies that got your attention in the first place. If you work in a hospital, you come into contact with companies that make sutures, surgical gowns, syringes, beds and bed pans, X-ray equipment, EKG machines; companies that help the hospital keep its costs down; companies that write the health insurance; companies that handle the billing. The grocery store is another hotbed of companies: dozens of them are represented in each aisle.
You also begin to notice when a competitor is doing a better job than the company that hired you. When people were lining up to buy Chrysler minivans, it wasn’t just the Chrysler salesmen who realized Chrysler was on its way to making record profits. It was also the Buick salesmen down the block, who sat around their empty showroom and realized that a lot of Buick customers must have switched to Chrysler.
This brings us to the numbers. That a company makes a popular product doesn’t mean you should automatically buy the stock. There’s a lot more you have to know before you invest. You have to know if the company is spending its cash wisely or frittering it away. You have to know how much it owes to the banks. You have to know if the sales are growing, and how fast. You have to know how much money it earned in past years, and how much it can expect to earn in the future. You have to know if the stock is selling at a fair price, a bargain price, or too high a price.
You have to know if the company is paying a dividend, and if so, how much of a dividend, and how often it is raised. Earnings, sales, debt, dividends, the price of the stock: These are some of the key numbers stockpickers must follow.
People go to graduate school to learn how to read and interpret these numbers, so this is not a subject that can be covered in depth in a primer such as this one. The best we can do is to give you a glimpse at the basic elements of a company’s finances, so you can begin to see how the numbers fit together. You’ll find this information in Appendix Two: Reading the Numbers—How to Decipher a Balance Sheet, on page 251.
No investor can possibly hope to keep up with the more than thirteen thousand companies whose stocks are traded on the major exchanges in the U.S. markets today. That’s why amateurs and pros alike are forced to cut down on their options by specializing in one kind of company or another. For instance, some investors buy stocks only in companies that have a habit of raising their dividends. Others look for companies whose earnings are growing by at least 20 percent a year.
You can specialize in a certain industry, such as electric utilities or restaurants or banks. You can specialize in small companies or large companies, new companies or old ones. You can specialize in companies that have fallen on hard times and are trying to make a comeback. (These are called “turnarounds.”) There are hundreds of different ways to skin this cat.
Investing is not an exact science, and no matter how hard you study the numbers and how much you learn about a company’s past performance, you can never be sure about its future performance. What will happen tomorrow is always a guess. Your job as an investor is to make educated guesses and not blind ones. Your job is to pick stocks and not pay too much for them, then to keep watching for good news or bad news coming out of the companies you own. You can use your knowledge to keep the risks to a minimum.