During the recent explosion in Oil prices, which may or may not be over, blue chip stocks that were affected positively were essentially canceled out by the stocks disrupted in a negative way.
There are tons of ways in which traders and investors exploit changes in the perception of supply and demand in energy, commodity and currency prices. With respect to Oil, traders may simply buy the futures contact itself, light sweet New York Crude for any number of months out. Or they may play the Gasoline, heating Oil or natural gas markets.
Often, investors will buy or sell shares of an ETF, or Exchange Traded Fund that is heavily weighted in the Oil, or Gold sector to prevent the risk of investing in only a few exploration, mining or manufacturing companies.
They may also further attempt to enhance their profits by using their investment in Jet Fuel to borrow shares of an Airline, to use an obvious example, and selling them short at the same time.
Sure, you can open up a new futures account, or buy Exxon Mobil on margin, but in the main stream world of investing, it will take a very large amount of capital and a good deal of time and risk to capitalize on a Ten Dollar move in a barrel of Oil or a Twenty Five Dollar move in the Price of Gold.
This is where Penny Stocks come in.
Aug 10, 2008
Aug 8, 2008
Minimizing Risks In Penny Stocks
To get an idea as to just how risky buying a Penny Stock could be, let's look at a worst case scenario, and then focus on how to avoid these types of situations. Seeing how high a stock has been in the past and how low it is today forces us to send an order through to our broker using half of our account value.
We noticed the stock because it skyrocketed today on high volume, and the press release that came with it makes the company seem unstoppable. We calm our nerves by telling ourselves we will sell the stock at a moments notice if it gets down to a certain level. The very next day the stock moves up a little bit more early in the morning, and we are euphoric, and even whisper that we can now sell the stock should it fall back down to break even, thereby making it risk free from here on out.
But this is not really an issue, because we are certain that the stock will not even go back down to those levels. Lunch time comes and volume slows to a standstill and you start to think about lunch yourself. When you return to the screen, you see a lot of activity on the Level II screen, and feel something is brewing; perhaps this is the big run.
The first few trades look good, but you soon comprehend that the stock is tanking fast, you are concerned but convince yourself that it must just be a shake out before the next peak. It has already fallen below your break even level and even below your point of no return. As you page through different time frames on your charting software, you quickly realize that your penny stock has now fallen back to where it was before the run began, and is even right near its all time low.
Instead of firing your sell order, you begin to hypothesis that if it was cheap when you first bought it, it must be at bargain basement levels now. You decide to use the rest of your account value to enter another buy order, and then quickly calculate how high the stock will have to go to break even. Solace is found in the fact that it is less than halfway between your two buy points, and you continue to hold for weeks, even months as the stock slides ever downward.
Perhaps the stock falls below a penny, and maybe you even scrap up a few more dollars to add to the position. Eventually, after trading between $.0001 and $.0002 for what seems like a lifetime, the company announces a 1 for 900 reverse stock split. After you find the new symbol and see your account updated, what seemed like a substantial position in the company has been reduced to a mere couple of hundred shares, but at least it is worth close to a dollar per share.
Over the next few days the stock plummets back to sub-penny land almost as fast as the pit in your stomach develops as you come to the devastating conclusion that selling the stock now would not even yield enough to cover the commission.
We noticed the stock because it skyrocketed today on high volume, and the press release that came with it makes the company seem unstoppable. We calm our nerves by telling ourselves we will sell the stock at a moments notice if it gets down to a certain level. The very next day the stock moves up a little bit more early in the morning, and we are euphoric, and even whisper that we can now sell the stock should it fall back down to break even, thereby making it risk free from here on out.
But this is not really an issue, because we are certain that the stock will not even go back down to those levels. Lunch time comes and volume slows to a standstill and you start to think about lunch yourself. When you return to the screen, you see a lot of activity on the Level II screen, and feel something is brewing; perhaps this is the big run.
The first few trades look good, but you soon comprehend that the stock is tanking fast, you are concerned but convince yourself that it must just be a shake out before the next peak. It has already fallen below your break even level and even below your point of no return. As you page through different time frames on your charting software, you quickly realize that your penny stock has now fallen back to where it was before the run began, and is even right near its all time low.
Instead of firing your sell order, you begin to hypothesis that if it was cheap when you first bought it, it must be at bargain basement levels now. You decide to use the rest of your account value to enter another buy order, and then quickly calculate how high the stock will have to go to break even. Solace is found in the fact that it is less than halfway between your two buy points, and you continue to hold for weeks, even months as the stock slides ever downward.
Perhaps the stock falls below a penny, and maybe you even scrap up a few more dollars to add to the position. Eventually, after trading between $.0001 and $.0002 for what seems like a lifetime, the company announces a 1 for 900 reverse stock split. After you find the new symbol and see your account updated, what seemed like a substantial position in the company has been reduced to a mere couple of hundred shares, but at least it is worth close to a dollar per share.
Over the next few days the stock plummets back to sub-penny land almost as fast as the pit in your stomach develops as you come to the devastating conclusion that selling the stock now would not even yield enough to cover the commission.
Aug 4, 2008
Picking The Right Broker
Many online brokers are suited quite well for penny stocks, others, however, are horrible. The first and foremost feature to check is share limitations.
With penny stocks you will be purchasing as many as a million shares or more at a time. A half a penny extra per share over say 1000 shares doesn't sound like much, but a million shares will cost you an extra 5000 dollars, and that’s just to get in. Most brokers that offer no share limitations typically charge a tiny bit more per trade, but it is definitely worth the cost.
At the present time, there is no need for the average day trader to spend tons of money on software.
The next necessity is to have a good trading platform. Most online brokerage firms offer perfectly sufficient real-time, streaming customizable charts, watch lists, time and sales, some screening ability and the all important level II for free as long as you’re an active trader.
It may appear as though you have to trade heavily for a quarter or so to get all of the features, but most of the time if you call and tell them that you’re an active trader they will let you install right away for free, or at least a nominal fee.
This goes hand in hand with trade minimums.
Do not be too concerned with how many trades you make a month to save a few bucks, as long as you get the software.
With penny stocks you will be purchasing as many as a million shares or more at a time. A half a penny extra per share over say 1000 shares doesn't sound like much, but a million shares will cost you an extra 5000 dollars, and that’s just to get in. Most brokers that offer no share limitations typically charge a tiny bit more per trade, but it is definitely worth the cost.
At the present time, there is no need for the average day trader to spend tons of money on software.
The next necessity is to have a good trading platform. Most online brokerage firms offer perfectly sufficient real-time, streaming customizable charts, watch lists, time and sales, some screening ability and the all important level II for free as long as you’re an active trader.
It may appear as though you have to trade heavily for a quarter or so to get all of the features, but most of the time if you call and tell them that you’re an active trader they will let you install right away for free, or at least a nominal fee.
This goes hand in hand with trade minimums.
Do not be too concerned with how many trades you make a month to save a few bucks, as long as you get the software.
Jul 22, 2008
Management The backbone of any successful company is strong management. The people at the top ultimately make the strategic decisions and therefore serve as a crucial factor determining the fate of the company.
To assess the strength of management, investors can simply ask the standard five Ws: who, where, what, when and why? Who? Do some research, and find out who is running the company. Among other things, you should know who its CEO, CFO, COO and CIO are. Then you can move onto the next question. Where? You need to find out where these people come from, specifically, their educational and employment backgrounds. Ask yourself if these backgrounds make the people suitable for directing the company in its industry.
A management team consisting of people who come from completely unrelated industries should raise questions. If the CEO of a newly-formed mining company previously worked in the industry, ask yourself whether he or she has the necessary qualities to lead a mining company to success. What and When? What is the management philosophy? In other words, in what style do these people intend to manage the company? Some managers are more personable, promoting an open, transparent and flexible way of running the business. Other management philosophies are more rigid and less adaptable, valuing policy and established logic above all in the decision-making process. You can discern the style of management by looking at its past actions or by reading the annual report's management, discussion & analysis (MD&A) section.
Ask yourself if you agree with this philosophy, and if it works for the company, given its size and the nature of its business. Once you know the style of the managers, find out when this team took over the company. Jack Welch, for example, was CEO of General Electric for over 20 years. His long tenure is a good indication that he was a successful and profitable manager; otherwise, the shareholders and the board of directors wouldn't have kept him around. If a company is doing poorly, one of the first actions taken is management restructuring, which is a nice way of saying "a change in management due to poor results". If you see a company continually changing managers, it may be a sign to invest elsewhere. At the same time, although restructuring is often brought on by poor management, it doesn't automatically mean the company is doomed.
For example, Chrysler Corp was on the brink of bankruptcy when Lee Iacocca, the new CEO, came in and installed a new management team that renewed Chrysler's status as a major player in the auto industry. So, management restructuring may be a positive sign, showing that a struggling company is making efforts to improve its outlook and is about to see a change for the better. Why? A final factor to investigate is why these people have become managers. Look at the manager's employment history, and try to see if these reasons are clear. Does this person have the qualities you believe are needed to make someone a good manager for this company? Has s/he been hired because of past successes and achievements, or has s/he acquired the position through questionable means, such as self-appointment after inheriting the company? Know What a Company Does and How it Makes Money A second important factor to consider when analyzing a company's qualitative factors is its product(s) or service(s).
How does this company make money? In fancy MBA parlance, the question would be "What is the company's business ?" Knowing how a company's activities will be profitable is fundamental to determining the worth of an investment. Often, people will boast about how profitable they think their new stock will be, but when you ask them what the company does, it seems their vision for the future is a little blurry: "Well, they have this high-tech thingamabob that does something with fiber-optic cables… ."
If you aren't sure how your company will make money, you can't really be sure that its stock will bring you a return. One of the biggest lessons taught by the dotcom bust of the late '90s is that not understanding a business model can have dire consequences. Many people had no idea how the dotcom companies were making money, or why they were trading so high. In fact, these companies weren't making any money; it's just that their growth potential was thought to be enormous. This led to overzealous buying based on a herd mentality, which in turn led to a market cras. But not everyone lost money when the bubble burst: Warren Buffett didn't invest in high-tech primarily because he didn't understand it. Although he was ostracized for this during the bubble, it saved him billions of dollars in the ensuing dotcom fallout. You need a solid understanding of how a company actually generates revenue in order to evaluate whether management is making the right decisions.
(FIndustry/Competition Aside from having a general understanding of what a company does, you should analyze the characteristics of its industry, such as its growth potential. A mediocre company in a great industry can provide a solid return, while a mediocre company in a poor industry will likely take a bite out of your portfolio. Of course, discerning a company's stage of growth will involve approximation, but common sense can go a long way: it's not hard to see that the growth prospects of a high-tech industry are greater than those of the railway industry. It's just a matter of asking yourself if the demand for the industry is growing. Market share is another important factor.
Look at how Microsoft thoroughly dominates the market for operating systems. Anyone trying to enter this market faces huge obstacles because Microsoft can take advantage of economies of scale. This does not mean that a company in a near monopoly situation is guaranteed to remain on top, but investing in a company that tries to take on the "500-pound gorilla" is a risky venture. Barriers against entry into a market can also give a company a significant qualitative advantage. Compare, for instance, the restaurant industry to the automobile or pharmaceuticals industries. Anybody can open up a restaurant because the skill level and capital required are very low.
The automobile and pharmaceuticals industries, on the other hand, have massive barriers to entry: large capital expenditures, exclusive distribution channels, government regulation, patents and so on. The harder it is for competition to enter an industry, the greater the advantage for existing firms. Brand Name A valuable brand reflects years of product development and marketing. Take for example the most popular brand name in the world: Coca-Cola. Many estimate that the intangible value of Coke's brand name is in the billions of dollars! Massive corporations such as Procter & Gamble rely on hundreds of popular brand names like Tide, Pampers and Head & Shoulders.
Having a portfolio of brands diversifies risk because the good performance of one brand can compensate for the underperformers. Keep in mind that some stock-pickers steer clear of any company that is branded around one individual. They do so because, if a company is tied too closely to one person, any bad news regarding that person may hinder the company's share performance even if the news has nothing to do with company operations.
A perfect example of this is the troubles faced by Martha Stewart Omnimedia as a result of Stewart's legal problems in 2004. Don't Overcomplicate You don't need a PhD in finance to recognize a good company. In his book "One Up on Wall Street", Peter Lynch discusses a time when his wife drew his attention to a great product with phenomenal marketing. Hanes was test marketing a product called L'eggs: women's pantyhose packaged in colorful plastic egg shells. Instead of selling these in department or specialty stores, Hanes put the product next to the candy bars, soda and gum at the checkouts of supermarkets - a brilliant idea since research showed that women frequented the supermarket about 12 times more often than the traditional outlets for pantyhose.
The product was a huge success and became the second highest-selling consumer product of the 1970s. Most women at the time would have easily seen the popularity of this product, and Lynch's wife was one of them. Thanks to her advice, he researched the company a little deeper and turned his investment in Hanes into a solid earner for Fidelity, while most of the male managers on Wall Street missed out. The point is that it's not only Wall Street analysts who are privy to information about companies; average everyday people can see such wonders too. If you see a local company expanding and doing well, dig a little deeper, ask around. Who knows, it may be the next Hanes.
To assess the strength of management, investors can simply ask the standard five Ws: who, where, what, when and why? Who? Do some research, and find out who is running the company. Among other things, you should know who its CEO, CFO, COO and CIO are. Then you can move onto the next question. Where? You need to find out where these people come from, specifically, their educational and employment backgrounds. Ask yourself if these backgrounds make the people suitable for directing the company in its industry.
A management team consisting of people who come from completely unrelated industries should raise questions. If the CEO of a newly-formed mining company previously worked in the industry, ask yourself whether he or she has the necessary qualities to lead a mining company to success. What and When? What is the management philosophy? In other words, in what style do these people intend to manage the company? Some managers are more personable, promoting an open, transparent and flexible way of running the business. Other management philosophies are more rigid and less adaptable, valuing policy and established logic above all in the decision-making process. You can discern the style of management by looking at its past actions or by reading the annual report's management, discussion & analysis (MD&A) section.
Ask yourself if you agree with this philosophy, and if it works for the company, given its size and the nature of its business. Once you know the style of the managers, find out when this team took over the company. Jack Welch, for example, was CEO of General Electric for over 20 years. His long tenure is a good indication that he was a successful and profitable manager; otherwise, the shareholders and the board of directors wouldn't have kept him around. If a company is doing poorly, one of the first actions taken is management restructuring, which is a nice way of saying "a change in management due to poor results". If you see a company continually changing managers, it may be a sign to invest elsewhere. At the same time, although restructuring is often brought on by poor management, it doesn't automatically mean the company is doomed.
For example, Chrysler Corp was on the brink of bankruptcy when Lee Iacocca, the new CEO, came in and installed a new management team that renewed Chrysler's status as a major player in the auto industry. So, management restructuring may be a positive sign, showing that a struggling company is making efforts to improve its outlook and is about to see a change for the better. Why? A final factor to investigate is why these people have become managers. Look at the manager's employment history, and try to see if these reasons are clear. Does this person have the qualities you believe are needed to make someone a good manager for this company? Has s/he been hired because of past successes and achievements, or has s/he acquired the position through questionable means, such as self-appointment after inheriting the company? Know What a Company Does and How it Makes Money A second important factor to consider when analyzing a company's qualitative factors is its product(s) or service(s).
How does this company make money? In fancy MBA parlance, the question would be "What is the company's business ?" Knowing how a company's activities will be profitable is fundamental to determining the worth of an investment. Often, people will boast about how profitable they think their new stock will be, but when you ask them what the company does, it seems their vision for the future is a little blurry: "Well, they have this high-tech thingamabob that does something with fiber-optic cables… ."
If you aren't sure how your company will make money, you can't really be sure that its stock will bring you a return. One of the biggest lessons taught by the dotcom bust of the late '90s is that not understanding a business model can have dire consequences. Many people had no idea how the dotcom companies were making money, or why they were trading so high. In fact, these companies weren't making any money; it's just that their growth potential was thought to be enormous. This led to overzealous buying based on a herd mentality, which in turn led to a market cras. But not everyone lost money when the bubble burst: Warren Buffett didn't invest in high-tech primarily because he didn't understand it. Although he was ostracized for this during the bubble, it saved him billions of dollars in the ensuing dotcom fallout. You need a solid understanding of how a company actually generates revenue in order to evaluate whether management is making the right decisions.
(FIndustry/Competition Aside from having a general understanding of what a company does, you should analyze the characteristics of its industry, such as its growth potential. A mediocre company in a great industry can provide a solid return, while a mediocre company in a poor industry will likely take a bite out of your portfolio. Of course, discerning a company's stage of growth will involve approximation, but common sense can go a long way: it's not hard to see that the growth prospects of a high-tech industry are greater than those of the railway industry. It's just a matter of asking yourself if the demand for the industry is growing. Market share is another important factor.
Look at how Microsoft thoroughly dominates the market for operating systems. Anyone trying to enter this market faces huge obstacles because Microsoft can take advantage of economies of scale. This does not mean that a company in a near monopoly situation is guaranteed to remain on top, but investing in a company that tries to take on the "500-pound gorilla" is a risky venture. Barriers against entry into a market can also give a company a significant qualitative advantage. Compare, for instance, the restaurant industry to the automobile or pharmaceuticals industries. Anybody can open up a restaurant because the skill level and capital required are very low.
The automobile and pharmaceuticals industries, on the other hand, have massive barriers to entry: large capital expenditures, exclusive distribution channels, government regulation, patents and so on. The harder it is for competition to enter an industry, the greater the advantage for existing firms. Brand Name A valuable brand reflects years of product development and marketing. Take for example the most popular brand name in the world: Coca-Cola. Many estimate that the intangible value of Coke's brand name is in the billions of dollars! Massive corporations such as Procter & Gamble rely on hundreds of popular brand names like Tide, Pampers and Head & Shoulders.
Having a portfolio of brands diversifies risk because the good performance of one brand can compensate for the underperformers. Keep in mind that some stock-pickers steer clear of any company that is branded around one individual. They do so because, if a company is tied too closely to one person, any bad news regarding that person may hinder the company's share performance even if the news has nothing to do with company operations.
A perfect example of this is the troubles faced by Martha Stewart Omnimedia as a result of Stewart's legal problems in 2004. Don't Overcomplicate You don't need a PhD in finance to recognize a good company. In his book "One Up on Wall Street", Peter Lynch discusses a time when his wife drew his attention to a great product with phenomenal marketing. Hanes was test marketing a product called L'eggs: women's pantyhose packaged in colorful plastic egg shells. Instead of selling these in department or specialty stores, Hanes put the product next to the candy bars, soda and gum at the checkouts of supermarkets - a brilliant idea since research showed that women frequented the supermarket about 12 times more often than the traditional outlets for pantyhose.
The product was a huge success and became the second highest-selling consumer product of the 1970s. Most women at the time would have easily seen the popularity of this product, and Lynch's wife was one of them. Thanks to her advice, he researched the company a little deeper and turned his investment in Hanes into a solid earner for Fidelity, while most of the male managers on Wall Street missed out. The point is that it's not only Wall Street analysts who are privy to information about companies; average everyday people can see such wonders too. If you see a local company expanding and doing well, dig a little deeper, ask around. Who knows, it may be the next Hanes.
Jul 18, 2008
fundamental analysis
Ever hear someone say that a company has "strong fundamentals"? The phrase is so overused that it's become somewhat of a cliché. Any analyst can refer to a company's fundamentals without actually saying anything meaningful. So here we define exactly what fundamentals are, how and why they are analyzed, and why fundamental analysis is often a great starting point to picking good companies.
The Theory Doing basic fundamental valuation is quite straightforward; all it takes is a little time and energy. The goal of analyzing a company's fundamentals is to find a stock's intrinsic value, a fancy term for what you believe a stock is really worth - as opposed to the value at which it is being traded in the marketplace. If the intrinsic value is more than the current share price, your analysis is showing that the stock is worth more than its price and that it makes sense to buy the stock. Although there are many different methods of finding the intrinsic value, the premise behind all the strategies is the same: a company is worth the sum of its discounted cash flows. In plain English, this means that a company is worth all of its future profits added together. And these future profits must be discounted to account for the time value of money, that is, the force by which the $1 you receive in a year's time is worth less than $1 you receive today.
The idea behind intrinsic value equaling future profits makes sense if you think about how a business provides value for its owner(s). If you have a small business, its worth is the money you can take from the company year after year (not the growth of the stock). And you can take something out of the company only if you have something left over after you pay for supplies and salaries, reinvest in new equipment, and so on.
A business is all about profits, plain old revenue minus expenses - the basis of intrinsic value. Greater Fool Theory One of the assumptions of the discounted cash flow theory is that people are rational, that nobody would buy a business for more than its future discounted cash flows. Since a stock represents ownership in a company, this assumption applies to the stock market. But why, then, do stocks exhibit such volatile movements? It doesn't make sense for a stock's price to fluctuate so much when the intrinsic value isn't changing by the minute. The fact is that many people do not view stocks as a representation of discounted cash flows, but as trading vehicles. Who cares what the cash flows are if you can sell the stock to somebody else for more than what you paid for it? Cynics of this approach have labeled it the greater fool theory, since the profit on a trade is not determined by a company's value, but about speculating whether you can sell to some other investor (the fool).
On the other hand, a trader would say that investors relying solely on fundamentals are leaving themselves at the mercy of the market instead of observing its trends and tendencies. This debate demonstrates the general difference between a technical and fundamental investor. A follower of technical analysis is guided not by value, but by the trends in the market often represented in charts. So, which is better: fundamental or technical? The answer is neither. As we mentioned in the introduction, every strategy has its own merits. In general, fundamental is thought of as a long-term strategy, while technical is used more for short-term strategies.
Putting Theory into Practice The idea of discounting cash flows seems okay in theory, but implementing it in real life is difficult. One of the most obvious challenges is determining how far into the future we should forecast cash flows. It's hard enough to predict next year's profits, so how can we predict the course of the next 10 years? What if a company goes out of business? What if a company survives for hundreds of years? All of these uncertainties and possibilities explain why there are many different models devised for discounting cash flows, but none completely escapes the complications posed by the uncertainty of the future.
The Theory Doing basic fundamental valuation is quite straightforward; all it takes is a little time and energy. The goal of analyzing a company's fundamentals is to find a stock's intrinsic value, a fancy term for what you believe a stock is really worth - as opposed to the value at which it is being traded in the marketplace. If the intrinsic value is more than the current share price, your analysis is showing that the stock is worth more than its price and that it makes sense to buy the stock. Although there are many different methods of finding the intrinsic value, the premise behind all the strategies is the same: a company is worth the sum of its discounted cash flows. In plain English, this means that a company is worth all of its future profits added together. And these future profits must be discounted to account for the time value of money, that is, the force by which the $1 you receive in a year's time is worth less than $1 you receive today.
The idea behind intrinsic value equaling future profits makes sense if you think about how a business provides value for its owner(s). If you have a small business, its worth is the money you can take from the company year after year (not the growth of the stock). And you can take something out of the company only if you have something left over after you pay for supplies and salaries, reinvest in new equipment, and so on.
A business is all about profits, plain old revenue minus expenses - the basis of intrinsic value. Greater Fool Theory One of the assumptions of the discounted cash flow theory is that people are rational, that nobody would buy a business for more than its future discounted cash flows. Since a stock represents ownership in a company, this assumption applies to the stock market. But why, then, do stocks exhibit such volatile movements? It doesn't make sense for a stock's price to fluctuate so much when the intrinsic value isn't changing by the minute. The fact is that many people do not view stocks as a representation of discounted cash flows, but as trading vehicles. Who cares what the cash flows are if you can sell the stock to somebody else for more than what you paid for it? Cynics of this approach have labeled it the greater fool theory, since the profit on a trade is not determined by a company's value, but about speculating whether you can sell to some other investor (the fool).
On the other hand, a trader would say that investors relying solely on fundamentals are leaving themselves at the mercy of the market instead of observing its trends and tendencies. This debate demonstrates the general difference between a technical and fundamental investor. A follower of technical analysis is guided not by value, but by the trends in the market often represented in charts. So, which is better: fundamental or technical? The answer is neither. As we mentioned in the introduction, every strategy has its own merits. In general, fundamental is thought of as a long-term strategy, while technical is used more for short-term strategies.
Putting Theory into Practice The idea of discounting cash flows seems okay in theory, but implementing it in real life is difficult. One of the most obvious challenges is determining how far into the future we should forecast cash flows. It's hard enough to predict next year's profits, so how can we predict the course of the next 10 years? What if a company goes out of business? What if a company survives for hundreds of years? All of these uncertainties and possibilities explain why there are many different models devised for discounting cash flows, but none completely escapes the complications posed by the uncertainty of the future.
Jul 14, 2008
stock picking
When it comes to personal finance and the accumulation of wealth, few subjects are more talked about than stocks.It's easy to understand why: playing the stock market is thrilling. But on this financial roller-coaster ride, we all want to experience the ups without the downs.
In this tutorial, we examine some of the most popular strategies for finding good stocks (or at least avoiding bad ones). In other words, we'll explore the art of stock-picking - selecting stocks based on a certain set of criteria, with the aim of achieving a rate of return that is greater than the market's overall average. Before exploring the vast world of stock-picking methodologies, we should address a few misconceptions.
Many investors new to the stock-picking scene believe that there is some infallible strategy that, once followed, will guarantee success. There is no foolproof system for picking stocks! If you are reading this tutorial in search of a magic key to unlock instant wealth, we're sorry, but we know of no such key. This doesn't mean you can't expand your wealth through the stock market. It's just better to think of stock-picking as an art rather than a science.
There are a few reasons for this:
So many factors affect a company's health that it is nearly impossible to construct a formula that will predict success. It is one thing to assemble data that you can work with, but quite another to determine which numbers are relevant.
A lot of information is intangible and cannot be measured. The quantifiable aspects of a company, such as profits, are easy enough to find. But how do you measure the qualitative factors, such as the company's staff, its competitive advantages, its reputation and so on? This combination of tangible and intangible aspects makes picking stocks a highly subjective, even intuitive process.
Because of the human (often irrational) element inherent in the forces that move the stock market, stocks do not always do what you anticipate they'll do. Emotions can change quickly and unpredictably.
And unfortunately, when confidence turns into fear, the stock market can be a dangerous place. The bottom line is that there is no one way to pick stocks. Better to think of every stock strategy as nothing more than an application of a theory - a "best guess" of how to invest. And sometimes two seemingly opposed theories can be successful at the same time. Perhaps just as important as considering theory, is determining how well an investment strategy fits your personal outlook, time frame, risk tolerance and the amount of time you want to devote to investing and picking stocks.
At this point, you may be asking yourself why stock-picking is so important. Why worry so much about it? Why spend hours doing it? The answer is simple: wealth. If you become a good stock-picker, you can increase your personal wealth exponentially.
Take Microsoft, for example. Had you invested in Bill Gates' brainchild at its IPo back in 1986 and simply held that investment, your return would have been somewhere in the neighborhood of 35,000% by spring of 2004. In other words, over an 18-year period, a $10,000 investment would have turned itself into a cool $3.5 million! (In fact, had you had this foresight in the bull market of the late '90s, your return could have been even greater.) With returns like this, it's no wonder that investors continue to hunt for "the next Microsoft". Without further ado, let's start by delving into one of the most basic and crucial aspects of stock-picking: fundamental analysis, whose theory underlies all of the strategies we explore in this tutorial (with the exception of the last section on technical analysis). Although there are many differences between each strategy, they all come down to finding the worth of a company. Keep this in mind as we move forward.
In this tutorial, we examine some of the most popular strategies for finding good stocks (or at least avoiding bad ones). In other words, we'll explore the art of stock-picking - selecting stocks based on a certain set of criteria, with the aim of achieving a rate of return that is greater than the market's overall average. Before exploring the vast world of stock-picking methodologies, we should address a few misconceptions.
Many investors new to the stock-picking scene believe that there is some infallible strategy that, once followed, will guarantee success. There is no foolproof system for picking stocks! If you are reading this tutorial in search of a magic key to unlock instant wealth, we're sorry, but we know of no such key. This doesn't mean you can't expand your wealth through the stock market. It's just better to think of stock-picking as an art rather than a science.
There are a few reasons for this:
So many factors affect a company's health that it is nearly impossible to construct a formula that will predict success. It is one thing to assemble data that you can work with, but quite another to determine which numbers are relevant.
A lot of information is intangible and cannot be measured. The quantifiable aspects of a company, such as profits, are easy enough to find. But how do you measure the qualitative factors, such as the company's staff, its competitive advantages, its reputation and so on? This combination of tangible and intangible aspects makes picking stocks a highly subjective, even intuitive process.
Because of the human (often irrational) element inherent in the forces that move the stock market, stocks do not always do what you anticipate they'll do. Emotions can change quickly and unpredictably.
And unfortunately, when confidence turns into fear, the stock market can be a dangerous place. The bottom line is that there is no one way to pick stocks. Better to think of every stock strategy as nothing more than an application of a theory - a "best guess" of how to invest. And sometimes two seemingly opposed theories can be successful at the same time. Perhaps just as important as considering theory, is determining how well an investment strategy fits your personal outlook, time frame, risk tolerance and the amount of time you want to devote to investing and picking stocks.
At this point, you may be asking yourself why stock-picking is so important. Why worry so much about it? Why spend hours doing it? The answer is simple: wealth. If you become a good stock-picker, you can increase your personal wealth exponentially.
Take Microsoft, for example. Had you invested in Bill Gates' brainchild at its IPo back in 1986 and simply held that investment, your return would have been somewhere in the neighborhood of 35,000% by spring of 2004. In other words, over an 18-year period, a $10,000 investment would have turned itself into a cool $3.5 million! (In fact, had you had this foresight in the bull market of the late '90s, your return could have been even greater.) With returns like this, it's no wonder that investors continue to hunt for "the next Microsoft". Without further ado, let's start by delving into one of the most basic and crucial aspects of stock-picking: fundamental analysis, whose theory underlies all of the strategies we explore in this tutorial (with the exception of the last section on technical analysis). Although there are many differences between each strategy, they all come down to finding the worth of a company. Keep this in mind as we move forward.
Jun 1, 2008
Investing in the Stock Market
Get educated:
Read about stocks and the market, take a seminar or class on investing and review online financial sites.
Step2 Develop financial goals and an investing and stock-picking strategy.
Step3 Research individual stocks by reading annual reports, quarterly reports and other documents on file with the Securities and Exchange Commission. Look them up online at www.freedgar.com
Step4 Invest in what you know. Consider the stocks of local companies with which you are familiar and in which you have confidence.
Step5 Check out the holdings of some successful mutual-fund companies. If they are winning with particular stocks, perhaps you will too.
Step6 Diversify. Avoid putting your money in just one or two stocks or, for that matter, in one or two industries.
Step7 Use a discount brokerage to buy stocks if you are confident in your investment skills and have the time to do your own investing. You'll save on commissions.
Step8 Buy stocks that you will feel comfortable holding for three to five years. Resist the temptation to dump a stock the moment its price drops a few percentage points. Give it a chance.
Warnings:
Know your appetite for risk before you start investing. The stock market can be a roller-coaster ride.
If you don't have time to research and review stocks daily, try investing in a mutual fund account, at least to get started.
Look for value. Use price-earnings ratios, usually reported in newspapers' stock tables, to compare a stock to industry norms before you buy.
Take advantage of investing through 401(k) plans, Individual Retirement Accounts and Keogh plans. These provide tax breaks to the investor.
Don't think that by investing all your money today, you will be a millionaire next month. Invest for the long term.
Read about stocks and the market, take a seminar or class on investing and review online financial sites.
Step2 Develop financial goals and an investing and stock-picking strategy.
Step3 Research individual stocks by reading annual reports, quarterly reports and other documents on file with the Securities and Exchange Commission. Look them up online at www.freedgar.com
Step4 Invest in what you know. Consider the stocks of local companies with which you are familiar and in which you have confidence.
Step5 Check out the holdings of some successful mutual-fund companies. If they are winning with particular stocks, perhaps you will too.
Step6 Diversify. Avoid putting your money in just one or two stocks or, for that matter, in one or two industries.
Step7 Use a discount brokerage to buy stocks if you are confident in your investment skills and have the time to do your own investing. You'll save on commissions.
Step8 Buy stocks that you will feel comfortable holding for three to five years. Resist the temptation to dump a stock the moment its price drops a few percentage points. Give it a chance.
Warnings:
Know your appetite for risk before you start investing. The stock market can be a roller-coaster ride.
If you don't have time to research and review stocks daily, try investing in a mutual fund account, at least to get started.
Look for value. Use price-earnings ratios, usually reported in newspapers' stock tables, to compare a stock to industry norms before you buy.
Take advantage of investing through 401(k) plans, Individual Retirement Accounts and Keogh plans. These provide tax breaks to the investor.
Don't think that by investing all your money today, you will be a millionaire next month. Invest for the long term.
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