How do you pick the right stocks? Although there is no single sure-fire method, here are some popular approaches:
Look for undervalued stocks. Find stocks whose price-earnings ratios (stock price divided by earnings per share) are below average for stocks in their industry. Or find stocks whose prices are below their companies' book value per share (book value is assets minus liabilities). Or find stocks selling at or near their lows for the past three to five years.
Price-earnings ratios and other data are available in reference works such as the Value Line Investment Survey or Standard & Poor's Stock Guide, at most large libraries. Or consult a broker.
Investing in undervalued stocks requires patience. It may be a long time before a cheap stock comes into favor and rises in price.
Look for takeover candidates. Find companies in industries ripe for takeovers. Or look for closely held companies whose owners might be willing to sell, or for companies whose managements might want to take the company private in a leveraged buyout. Or look for companies that are cash-rich; the acquiring company can use the cash to recover part of the acquisition cost. Be careful, however. Stocks may already be bid up on previous takeover speculation.
Look for companies whose earnings prospects are improving. Stocks of companies whose earnings estimates are raised by analysts often do well long after the estimates are made.
Look for turnaround candidates. Find depressed companies that may have recently installed new managements or undertaken restructuring plans.
Look for companies with good ideas, products or services. Sometimes you use products or services that you think will become real winners. Find out who makes them.
Copy what insiders or savvy investors are doing. Find companies whose corporate officers are heavily buying their own companies' stock. Such buying, which must be reported to the Securities and Exchange Commission, often indicates a company's prospects are about to improve. Newsletters that track such insider buying include:
The Insiders, 3471 N. Federal Highway, Fort Lauderdale, Fla. 33306, (305) 563-9000.
Consensus of Insiders, P.O. Box 24349, Fort Lauderdale, Fla. 33307, (305) 563-6827.
Insiders' Chronicle, P.O. Box 272977, Boca Raton, Fla. 33427, (305) 394-3404.
Or find companies whose stocks are being bought by proven stock pickers, such as Berkshire Hathaway Chairman Warren E. Buffet, or by corporate raiders, such as T. Boone Pickens Jr. or Carl C. Icahn. Such information also must be filed with the SEC if the acquirer buys 5% or more of the target company's stock. Newsletters tracking such information include:
Wealth Monitors, 1001 E. 101st Terrace, Suite 220, Kansas City, Mo. 64131, (816) 941-7990.
Street Smart Investing, 2651 Strang Blvd., Yorktown Heights, N.Y. 10598, (914) 962-4646.
Special Situation Report, P.O. Box 167, Rochester, N.Y. 14601, (716) 325-7100.
Track volume and price trends. This is called technical analysis, under which you monitor investor psychology as shown in volume and price movements, and pay less attention to the financial position of a company as reflected in its earnings or debt.
One way to apply technical analysis to individual stocks is to look for issues setting new highs on stronger-than-normal trading volume. They may have a lot of gain left in them. Conversely, look for stocks setting new lows on weaker-than-normal volume. They could be ready to turn around.
Newsletters using technical analysis include:
The Elliot Wave Theorist, P.O. Box 1618, Gainesville, Ga. 30503, (404) 536-0309.
Stockmarket Cycles, 2260 Cahuenga Blvd., Suite 305, Los Angeles, Calif. 90068, (213) 465-5543.
Go against the crowd. This is called "contrarian analysis," under which you do the opposite of what most investors are doing at any particular time. Under this thinking, buy stocks when most advisers are bearish, and sell when most are bullish. Indeed, many tops for the entire market have been set when the majority of advisers were bullish; they had all their clients' cash in the market and thus there was no cash left on the sidelines to buy stocks and push prices higher.
Newsletters which track adviser sentiment include:
Investors Intelligence, 30 Church St., New Rochelle, N.Y. 10801, (914) 632-0422.
Bullish Consensus, P.O. Box 90490, Pasadena, Calif. 91109, (818) 441-3457.
Forget about picking individual stocks. Instead, invest in mutual funds and let professionals do it for you.