How to Pick a Quality Stock for Investment

There are certain characteristics that identify quality stocks for investment purposes. This entry discusses some of the factors that may be used to identify winning stocks.

Steps

  1. A good place to start when looking for a stock to purchase is the list of top percentage gainers for that particular day. These lists are found on USA Today, CNN.Money, and elsewhere.
  2. From this list, emphasize stocks close to or higher than $10/share. Stocks much under $10 are generally of lower quality. Although one can purchase more shares of a lower-priced stock, that doesn’t necessarily mean that your chances of a successful investment are greater; in fact they may be reduced with so-called “penny” stocks.
  3. Check the latest quarter earnings report. These are easily found on the Yahoo Finance website. After entering a stock symbol, check for “Headlines” along the left side of the page. Start with current news and go back looking for the most recent earnings report. Insist on revenue growth and earnings growth before committing new funds to an investment.
  4. Review the Morning star.com “5-Yr Restated” financial page. Enter your stock symbol on the Morning star.com website and then look for “financials” along the left side. Click on the tab for “5-Yr Restated” along the top of the graphs. Look for consistent revenue and earnings growth the past 4-5 years. Also look for positive and hopefully growing free cash flow. This is a good indicator of a “healthy” company. Also check the balance sheet. Preferably, there are a lot more assets than liabilities. Particularly cash and other current assets should exceed current liabilities and if possible, be sufficient to cover the long-term liabilities as well.
  5. Look on Yahoo for some “Key Statistics”. All things being equal, a p/e that is under 30, a PEG close to 1.0, and a price/sales ratio that is in the middle or lower in a company’s industrial grouping is a plus. Check also for the short ratio, if the ratio is high, at least over 3.0, then this means there are a lot of short-sellers probably present, and this may result in a squeeze of short-sellers if the stock price rises and they are scrambling to cover their borrowed shares already sold with newly purchased shares. If the stock pays a dividend as well, that is great!
  6. Look at a chart. Use stockcharts.com
    • Know when to buy a stock. If you have a portfolio, consider an internally generated signal to make a purchase. If you have recently sold a stock at a loss, do not rush to replace it. Rather sit in cash and wait for a proper buying signal.
Know when to sell a stock. Keep losses small no matter how long you may have owned a stock. Sell your winning stocks slowly and piecemeal. Sell your losing stocks quickly and completely. Often that is enough to bias your account in a winning direction!

Tips

  • Don’t trade the headlines. Find quality and stick with it.
  • Know where you are headed. Without a plan you are driving without a map.
  • Diversify not only with companies but with asset classes. Do not put all your money in aggressive investment categories. Spread the risk across growth and income (companies that are profitable and pay dividends), growth (companies that are more prone to grow over time due to favorable¬†fundamentals¬†such as market position, products, etc) and a small amount in aggressive as mentioned.
  • Before investing you might want to try a simulator. It’s fun, safe, free, and a good way of finding out if investing in stocks is really what you want to do. investopedia.com has a good simulator.

Warnings

  • Remember to always consult with a professional investment advisor. I am an amateur investor! But doing your homework and having your own understanding of investments may be very helpful to you.
  • Remember that consulting with a professional investment adviser will sometimes lead you to a stock which that investment advisor is being paid to push rather than one which is good for your portfolio and your future.
  • Picking stocks from a list of top percentage gainers and/or from Morning star ratings tend to produce stocks that have at most 3-6 months left in their growth before they go the other direction. This is because the market already value them at their proper levels.
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This entry was posted on Monday, November 21st, 2011 at 11:45 am and is filed under Finance. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.