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Stock investors are generally one of two types:
Technicians, also known as chartists, forecast future stock prices by using past price trends. They tend to buy and sell stock in a short time, sometimes within an hour. The chartists, who chart past stock price patterns, ignore fundamental factors, such as book values, dividends, and earnings. They buy and sell stock by identifying the trend of stock price movements.
For example, they use a popular tool called 200-day moving averages (the arithmetic average of the past 200 days of stock closing prices) to determine the time to buy and sell stocks. When stock prices rise above the 200-day moving average, technicians buy the stock. When current prices fall below the average, they sell the stock.
Although there are followers of technical traders in the stock market, young investors should be aware of the high transaction costs and high taxes when trading stock frequently; moreover, they should consider the emotional pressure of following the daily ups and downs of the short-term market.
Fundamentalists are also called value investors. They look for the value growth of a company in the long-run. Fundamentalists look at factors such as earnings, dividends, and book values. They expect stock prices to go up as earnings of the company grow. They use a buy-and-hold approach in stock investing.
Unlike technicians, fundamentalists ignore the daily ups and downs of the market. If the stock price drops due to market rumors, they view the drop as an opportunity to buy more stock at a lower price. They believe that in the long run, if one buys stocks of well-managed and solid, growing companies, the stock price will eventually reflect the performance of these companies. To take advantage of rising stock prices of growing companies, young investors should do their homework and select stocks carefully.
There is no stock-picking method that can predict a sure winner all the time. We, however, will provide you with three fundamental approaches that will increase your chance of picking winning stocks.
You can use one or any combination of these approaches to assist you with stock picking. Most importantly, do your homework and use a lot of common sense.
Peter Lynch is the legendary stock picker who from 1977-1990 managed the Fidelity Magellan Fund, the best performer in mutual funds over that period. The fund outperformed the S & P 500 Index by a compound annual rate of 10.3%. A $1,000 invested in Magellan in 1977, when Peter Lynch became the fund manager, was worth nearly $21,000 at the time he retired after thirteen years.
Peter Lynch believes that amateur investors can outperform Wall Street experts since the best investing clues can be found at the mall, on the school playground, or at people’s workplace. He explains that kids have a chance to learn about successful companies in their daily lives before Wall Street analysts find out about the companies.
The Wall Street guru says that the secret to his success is his ability to "think like an amateur." He offers a common-sense approach to stock picking: Know the "story," or everything about a company, before buying a stock; then follow the "story" after buying the stock. He says, "Don’t sell the stock if the 'story' is still good, whether the market is up or down."
To begin to select a "story," find publicly traded companies that provide good products and services. You can begin to gather information for your "story" every time you walk into a mall, go to a restaurant, or play with your friends. That is, wherever you go, do firsthand observations on companies or products to gauge whether the company is strong and growing. See for yourself whether the store is clean or messy. Are people lining up at the cash register or does the store look empty? Are the customers happy with the services or do they complain a lot? You are not likely to see an empty McDonalds or Wal-Mart.
On the playground, see what brand of soda your friends are drinking. Are most of them wearing Nike or Reebok shoes? Notice what new sports, such as roller hockey, have become popular. Then, look for companies that will benefit from the trend.
Also check with your parents, relatives, and neighbors who are doctors, engineers, and bankers. Your neighborhood doctor knows which companies make excellent drugs or the best medical equipment. Your engineer dad knows which companies have a dominant position in computer software or hardware. Your uncle banker knows which banks are the most profitable.
Once you begin to take notice of some of these companies, your next step is to learn more about the "story" of the company before you invest in it. You can learn more about the "story" from resources such as trade magazines, annual reports, and the Internet. As the "story" goes on, you will want to know what must happen for the company to continue its growth spurts, as well as the pitfalls that may slow its earnings.
Peter Lynch believes that, in the long run, there is a strong correlation between the success of the company and the success of the stock. So look for the success stories. He further suggests that every few months, it is worth while to recheck the company’s "story." That may involve checking the stores to see if there are still lines at the cash registers or new developments of the "story" from your neighbor’s workplace. Also, check the earnings and growth from the company’s quarterly reports or from the latest Value Line. As long as you own the stock, the "story" will never end.
As a young investor, you should start looking at the world through a stock picker’s eyes. Better yet, you can collaborate with other kids across the Internet about your investment ideas. Click here to collaborate with other investors across the Internet.
Warren Buffett is one of the most successful stock investors in our time. In January 1996, he was named the richest American, with an estimated net worth of over $16 billion.
When Mr. Buffett invests, he sees a business rather than just a stock price. He finds good companies that will do well even in a recession. He does his homework to find the real value of a company and to learn about its management. If the company stock price is considerably below the real value of the company, he quietly buys up as many shares as he can get.
He is not too concerned about the day-to-day fluctuations of the market. He is not worried about the up-and-down cycles of the economy. He holds onto stocks for a long time. He regrets every time he sold some shares because the stock has gone up to a much higher price.
You don’t have to buy millions of shares to follow the Buffett Way. As a small investor, you can apply the same strategy and do relatively well. In a nutshell, here is the Warren Buffett Way of investing:
The Value Line Investment Survey (found in your local library in the reference section) provides an easy-to-use format that gives the relevant statistical and analytical information in a single-page report for each of 1,700 companies. Using Value Line is the analytical way of picking and screening stocks. With the help of Value Line, you don’t need to be a professional money manager to make informed judgments in stock picking. You can quickly develop a list of investment candidates from the 1,700 companies in the Value Line Survey report. The key factors noted in Value Line that will help you pick stocks are
The industry rank of 95 industries is found in the first booklet of Value Line contains . Pick stocks with an industry rank in the top twenties.
2. Timeliness and Safety Ranks
Timeliness refers to how well (1 being highest and 5, lowest) Value Line thinks a stock will do in the coming twelve months. Safety refers to how safe Value Line thinks that stock is. Stocks ranked 1 (highest) or 2 (above average) for Timeliness and Safety are those you should focus on. About 100 companies at a given time are ranked "1" for Timeliness. From this list of 100 stocks, select 10 to 20 prospective stocks to put on your buy list. Then, you should do more research on these companies to narrow down the list to a smaller potential number of stocks that represent the best value and lowest risk.
3. Beta
Beta is an indicator that measures the stock’s sensitivity to fluctuations in the market (NYSE average). A beta of 1 means that the stock price is likely to move up and down at the same rate as the market. A beta of 1.2 indicates that the stock price is likely to rise or drop by 20% more than the overall market. If you are an aggressive investor, you might want to pick stocks with a higher beta like 1.6 because the stock is likely to move up faster in an up market. However, in a down market, a high beta stock tends to come down faster. If you are a conservative investor, pick a stock with a beta close to one like 1.1 or 0.9.
4. Debt
Debt shows how much the company owes. For most cases, just make sure that the company has less than 35% of its assets in debt. The lower the debt, the less chance the company will go bankrupt; hence, the safer the investment. Two exceptions are Fannie Mae and Freddie Mac because their business is buying and selling loans.
5. Earning Per Share (EPS)
Earnings per share is the company's profit divided by the total number of shares. Value Line lists the stocks' EPS for the prior fifteen years and projects the future EPS for the next two years. As a young investor, you should look for a company with a solid yearly growth rate of 15% or even higher. This 15% indicates a growth stock whose stock price is likely at least to double in five years. (See the Rule of 72.)
6. Cash Flow and Stock Price
Value Line uses an estimate of future earnings and cash flow to project a range of stock prices in five years. Cash flow is the money a company has left after paying dividends (bonuses to shareholders).You should look for a project price that at least doubles the current stock price in five years.
7. Price-earnings Ratio (P/E)
The P/E ratios is the ratio found by dividing the most recent stock price by the last six months of earnings plus earnings estimated for the next six months. This ratio indicates if a stock is undervalued, overvalued, or the right price. The P/E ratio can be viewed in historical perspective by looking at the 10-year median or the 10-year average of the P/E.
A current P/E that is higher than a stock’s 10-year median P/E could mean that the stock is overvalued. You should look into other factors such as expected growth of a company, which is found on Value Line's single page report. If a stock’s P/E ratio is lower than the growth rate, you will not overpay for the stock.
8. Margin
Look for an operating margin and a net profit margin on the company you are researching. Compare these numbers to other companies in the same industry. The higher the margin, the better. High margins indicate that the company has good management and proprietary technologies. For example, Microsoft's net profit margin is usually in the mid-20 percent range, which is very good compared to other companies in the industry, which have a net profit margin of less than 15% on average.
9. Percent Earned on Net Worth
Net worth is the total shareholders’ wealth in a company. Percent earned net worth is the annual earnings of a company divided by the shareholders' net worth. The higher this percentage, the better. Look at the historical trend for this ratio and select stocks with a minimum of 15% of future projected earned on net worth. A well-managed company can consistently double this percentage over the years.
After you find some companies that interest you, you should get as much information as possible about these companies. You should also find out about the political and economical factors that will affect the profitability of the company. Click here to go to Stock Analysis.
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