My first stock purchase ever was 40 shares of DPS. I loved Dr. Pepper, and I googled, “Is DPS a good stock?” Apparently, the answer was yes, because I proceeded to dump most of my life savings (a hair over $1000) into the stock. Nobody accused me of being a sophisticated investor at the time, but I may have been normal.
How many investors never bother to ask themselves anything more than, “Good or Bad?” If you’re choosing stocks for your portfolio, you need more sophisticated criteria. These are a few things every DIY investor should consider.
Income statements, balance sheets and rate of growth
If you’re reading individual company income statements and balance sheets, you should give yourself a pat on the back. Most investor’s don’t bother. They hear a hot tip, and they buy. They get nervous and they sell. But income statements and balance sheets don’t tell you anything in isolation. A company’s balance sheet may be in the red, but it’s not necessarily a bad company to buy. If the company shows evidence of a turnaround, it could be an undervalued asset.
The same thing holds true with an income statement. A company might not be profitable, but if they are growing their revenues, it might be valuable in the future. When you’re evaluating an individual stock, consider the absolute numbers, but also consider the rate of growth you can expect going forward. For a stock price to increase over time, profitability needs to outpace most analysts expectations of the company.
Reviewing a company’s historical prices, and understanding how they’ve performed relative to competitors and indexes can offer you insights into how it may perform in the future. At DIY.Fund, we give you the tools that you need to understand historical pricing and trends, so that you can buy and sell your stocks with confidence.
What is a company’s strategic advantage?
Stock for excellent companies sells at price/earnings multiples higher than peer companies. For example, in 2015, Amazon sold at P/E multiples of 631.09. Other retailers sold at P/E multiples in the teens and twenties.Why can Amazon command such a premium? It’s possible that Amazon is overvalued, but the huge premium comes from Amazon’s distinct competitive advantages. No other retailer has the distribution, reach, and trust that Amazon has. Most analysts see Amazon as the retailer of the future.
When you see a company with a strategic advantage, begin to watch the stock prices, and the price relative to competitors in the sector. Seeing these can help you determine if you’ll be fairly rewarded for risking your money on a particular stock.
Picking winning stocks vs. Planning a portfolio
At DIY.Fund, we help DIY investors create meaningful portfolios. Most investors dream of picking winning securities that will drive their alpha ever higher. However, picking winners should not be the primary goal for long term investors. A diversified, well managed portfolio will help you keep our wealth. Speculators will bet all their money on a few stocks without thinking about the consequences to their portfolio. However, investors will review the consequences to their portfolio before they invest.
You cannot control the whims of the market, but you can control your portfolio. When you’re investing in stocks, you need to consider your overall portfolio strategy, and not just the strength of an individual asset.