Stocks 101
03-28-99
Joey
Stock-Picking 101—a Primer
Among the basic principles of investing: pull the
"weeds" but not the "flowers" from your stock portfolio. (ABCNEWS.com)
By Andrew Greta TheStreet.com Successful investing often
boils down to a few basic principles and a healthy dose of common sense.
In part one and part two of this series
we looked at the best tools for evaluating stock. Here we look at seven basic maxims I
collected from my four years as a broker that may prove helpful to those just staring down
the yellow brick road. Principle No. 1: You don't have to be right all of the time to make
a ton of money. The casino operators know this one by heart. On a given roulette, the
house wins just over half of the time. Most investors would probably call a 51% hit rate
pretty abysmal performance, but not the manager of Harrah's. He's too busy in the back
room counting the 1 or 2 cents on every single dollar that passes through each station and
piling up the pennies by the millions. You'll never be right
about every stock you pick, so don't get too worked up about it (sure takes the pressure
off, doesn't it?). Instead, focus on getting the best odds you can using a system like the
one I've described in this series, and try to gain more on your winners than you lose on
your losers, which brings us to... Principle No. 2: Pull the weeds, not the flowers. Be
quick to sell the stocks that don't work out and slow to take profits on the winners. Too
many clients I know lock in small gains and take huge losses due to some quirk in their
primal greed response. If you can turn the tables by, say
limiting losses to 10% and averaging 30% on your winners, you only have to be right one
time out of three to make money. But, how do you bring yourself to cut loose the trophy
fish of a lifetime that's heading straight for the bottom, dragging you and your boat with
it? Principle No. 3: Act on facts, not emotions. Parents always think that their kids are
the cutest in the world, but an ugly baby is still ugly. Don't get blinded by your own
prejudices into making a prince out of the frog next door. Realize that just because you
feel a certain way about a stock, industry, product or service, doesn't mean that anyone
else does. Check it out with the objective shades on, and remember: The market is never
wrong, it just "is." Principle No. 4: Use a disciplined approach. You don't
change your golf swing every time you tee up, right? Then why use different criteria every
time you pick a stock? Stick with a system that fits your style
and use it every time you make a move -- for, say, 20 round-trip trades or more. Then, if
you see some areas to change for better performance, do it, but stay with the system and
don't second-guess yourself. Principle No. 5: In the long run, earnings drive stock
prices, period. On any given day, stock prices jump around like a bunch of hyperactive
8-year-olds due to all kinds of factors beyond your control. However, as a beginning
investor, forget about trying to take advantage of those gyrations.
Face the facts that you'll probably be the last to know about any
information that drives prices in the short run, and focus on hitting consistent singles
over months and years instead of trying to blast a home run once a decade. The way to do
that is by focusing on a company's earnings growth and the factors that contribute to that
growth as a primary factor in picking your stocks. It's really pretty simple, if the
company is making money, you, as part owner, will make money too. Principle No. 6: Buy
high and sell higher. In other words, don't rule out a stock just because it's at the top
of its trading range. The laws of Newton do not necessarily apply to the stock market. For
example, an investor that picked up Gillette any time over the last decade would have
probably been buying at an all-time high. Yet $10 thou invested over that same time frame
would have grown to nearly $200,000 today. What went up, kept going up.
Put another way, don't go bottom-fishing unless you're trying to
hook some sickly looking carp that's probably down there for a reason. That's not to say
that you should buy the latest Net-Hype IPO on opening day at a 50-point premium. Just use
your head and follow the process in parts I and II, which should keep you safe from fits
of recklessness. Principle No. 7: Never force a trade. If nothing looks good, sit tight;
there's probably a reason. New opportunities come up all the time, so there's nothing
wrong with picking your shots instead of randomly blasting through the woods. On the other
hand, if a stock pops up that passes all of your screens, pull the trigger. Don't wait
around for something better to saunter by. By following these
principles, you'll hopefully wind up with a dose of added confidence as you head into the
wilds looking for your first kill. Or at least you'll keep you from shooting yourself in
the head by accident.
