Taking the Mystery Out of Stock Investments

When it comes to investing in the stock market, individual investors seem to seldom get it right. They rush to buy stocks when the market is about to peak. They sell stocks frantically when the market is in a free fall. And they often acknowledge that much about buying and selling corporate shares seems complex--sometimes even mysterious.

The truth is there is very little that’s mysterious about Wall Street. Anyone who has basic mathematical skills and a lot of common sense is in a position to buy and sell company shares profitably. The trick is knowing the rules, investment experts say.

The first rule, though, is to determine whether you are a good candidate for stock market investment in the first place. That requires some soul searching and honest self-analysis, said Ralph Bloch, analyst at the investment house of Raymond James & Associates.


“Ask yourself how you would feel if you lost 10% to 15% of your money. Would it change your lifestyle? Would it make you crazy?” Bloch said. “If the answers to those questions are yes, you don’t belong in the stock market.”

Why? Even though the stock market tends to outperform more conservative investments over the long haul, stock prices can be exceptionally volatile. If your blood pressure spikes with every market decline, the enriched return you might earn on Wall Street isn’t worth the emotional cost.

Moreover, if your investment horizon is short, you might be better off with a more stable vehicle, such as a certificate of deposit. Certainly there is nothing exciting or sexy about an insured bank deposit. But if the deposit is below the insured limit of $100,000, you never lose your principal. You also know from the outset exactly how much interest you’ll earn on your money over a particular period of time.

But if your time horizon is reasonably long and you are willing to risk losing some money, you are probably a good candidate for stock market investing.

Still with me? Now decide how you want to invest. Do you want to buy shares in a mutual fund so that someone else, who presumably is experienced and savvy, can pick the stocks? Or do you want to do the driving yourself?

If you opt for a mutual fund, you should examine three things. The fund’s record, its “load” or up-front fees and its continuing management fees.

Several companies analyze mutual fund performance. Lipper Analytical Services, for example, comes out with quarterly updates of how individual funds have done over various periods of time. A summarized version of these rankings is often published by major newspapers, including the Los Angeles Times.

Consider funds that have consistently strong performance over longer periods--a year, five years and 10 years. Quarter-to-quarter performance should not be an issue when your time frame is much longer.

Costs should also be a consideration, since every dollar you pay comes out of your ultimate investment return.

The process is more difficult if you decide that you want to pick the stocks yourself.

To do this well, you need to become educated about the market, which will probably take several hours a week. Read financial publications, check individual stock prices and think about subscribing to an investment advisory service such as Value Line. (A subscription to Value Line will cost you roughly $525 annually.)

Through this research, you should learn what kind of volatility to expect and how to determine whether overall stock prices are cheap or expensive.

Although there are many ways to determine the relative costs of stocks, the two most widely used are price/earnings ratios and dividend yields. (Calculate current P/E ratios by dividing the per-share market price by estimated earnings. Dividend yield is determined by dividing the full-year dividend by market value.)

Generally speaking, when dividend yields are below 3% and price earnings ratios have reached 20, stocks are probably dangerously expensive. When P/E ratios are below 10 and dividend yields have risen to the 6% range, stocks are probably quite cheap, said Hugh Johnson, chief investment officer for First Albany Corp. in New York. You, of course, want to buy when shares are cheap and sell when they get expensive.

A cautionary note: Don’t invest on “tips.” Don’t invest without personally checking out the company and its history. And don’t invest with a person or company you don’t know.

Do invest in companies you understand.

You should be able to picture how this company fits into society today, and what it will be doing in the future. Think about trends and demographic shifts that will hurt or benefit this particular company, and then check out the company’s history.

Make sure the company has consistent earnings--10 or more years of back-to-back profit increases--and that it doesn’t slash its dividend at every hint of trouble. (You can overlook a bad year or two, but shouldn’t overlook indications of instability.)

Then compare the company’s traditional price/earnings ratio and dividend yield with today’s numbers. If the company’s shares are cheap by historical standards and there is no good reason for the low price--such as an earnings reversal--it may be time to buy. If the shares are expensive by traditional standards, consider selling.

Lastly, be aware of brokerage costs. Even with a discount broker, you will generally pay between $35 and $100 every time you buy or sell shares. This should not hinder reasonable trading, but it should be part of your analysis.