Want to Buy Individual Stocks? A Few Pointers
New investors who become sold on mutual funds as a way to get into the stock market sometimes become so enamored of funds they begin to wonder why anyone would buy individual shares in companies. But there are plenty of reasons to put yourself in control of your investments. Here’s a primer for an individual stock picker.
*
Q: Why not simply stick to funds? Why bother with individual stocks at all?
*
A: Here are five reasons: You can take advantage of special knowledge of a company that other investors lack. You can manage your tax liability so as not to be hit with a bill for capital gains whenever a fund manager wants to take profits. You can, in many cases, keep your costs lower than with funds. You can get a good education in investing and in business in general. And, because these stock picks are your own, you may have more fun and gain more personal satisfaction than with funds.
*
Q: How many stocks should I own?
*
A: A large portfolio is difficult for a small investor to manage. A good strategy is to put half your investing money into mutual funds (where you’ll get the diversification that diminishes risk) and then divide the other half among five to 10 stocks. Start with three or four and then buy others as you are inspired.
*
Q: What’s the first step in deciding which stocks to buy?
*
A: The best investing ideas often are the ones with which you have personal contact--at work or at home. It is remarkable, but, with thousands of choices, most investors make the mistake of buying shares of companies they don’t understand. Dentists, for example, would rather buy shares of oil drilling stocks than tooth drilling stocks.
Peter Lynch, the former manager of the top-performing Fidelity Magellan fund, wrote in his book “One Up on Wall Street” that he often stumbled “onto the big winners in extracurricular situations,” the same way you could.
“Taco Bell--I was impressed with the burrito on a trip to California. La Quinta Motor Inns-- somebody at a rival Holiday Inn told me about it. Volvo--my family and friends drive this car. Apple Computer--my kids had one at home, and then the systems manager bought several for the office.” Lynch also made a huge score in the stock of Hanes after his wife noticed the popularity of L’eggs, the cleverly packaged pantyhose being tested at the time in supermarkets.
Of course, just finding a company with a good product or service isn’t the end of the process. The stock could be overpriced; new competition may be driving down profit, or management may be departing or getting tired. To find out whether you should buy a stock, you’ll need to do more research.
*
Q: Where do I go to get information on stocks?
*
A: My favorite source is the Value Line Investment Survey, a subscription service that’s updated weekly. Value Line, available at most libraries, provides a fact-crammed page of statistics and analysis on each of 2,000 stocks. You should also write or phone companies to get their most recent annual reports and quarterly statements.
You don’t need a degree in accounting to understand a company’s track record. A good tool for analyzing the figures is the Stock Selection Guide of the National Assn. of Investors Corp., a nonprofit organization that charges $35 to join. Its phone number is (810) 583-6242.
Research, some of it excellent, is also available through brokers--and that is one reason paying commissions to a full-service firm is often worthwhile, especially if you’re a buy-and-hold investor who won’t generate many commissions. But be aware that the research of many firms errs on the side of enthusiasm.
*
Q: Am I ready to buy now?
*
A: No; we need to talk philosophy. You should have a model in mind when you buy stocks. Most investors make the mistake of thinking of their stocks only as symbols and numbers on a newspaper page.
But Warren Buffett, the highly successful investor who is chairman of Berkshire Hathaway Inc., says his mentor, the late Benjamin Graham, taught him two principles springing from very different world views:
First, “look at stocks as part-ownership of a business.” When picking stocks, you should be choosing the companies with which you want to be a partner. Second, realize that you can sometimes buy into one of these companies at a bargain price. That’s because a fellow named Mr. Market will make you an offer every day--but, lucky for you, it’s not necessarily an offer based on the true value of the stock.
“The more manic-depressive this chap is, the greater opportunities available to the investor,” Buffett wrote in his 1993 Berkshire report. “A wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.”
That’s when you should buy. In the meantime, don’t worry about daily price fluctuations.
*
Q: How do I know what a stock is truly worth?
*
A: Unfortunately, there’s no easy answer to this question, but here’s one popular measurement: the price-to-earnings, or P-E, ratio. That’s the number of dollars Mr. Market is willing to pay on a given day for every dollar of profit that a company makes.
Thus, if Marriott International Inc. costs $36 a share and its profit over the past 12 months was $1.80 a share, its P-E is 20, or a little more than the market as a whole. When a stock falls out of favor, its P-E usually drops--often beyond reason. If Marriott’s P-E plummeted to 12 while its business stayed strong, it would make a superb buy.
But P-E ratios can be misleading, and deciding on a figure can be more art than science. For one thing, they look backward at previously reported profit. And you may see different P-Es for the same company in various publications. Company profit is affected by selling divisions, buying out employees and dozens of other items that do not reflect regular operating income. Although most rating services try to eliminate “extraordinary” or “one-time” items, the definition of those can vary.
*
Q: Is there a low-cost way to buy stocks without a broker?
*
A: If you join the National Assn. of Investors Corp., you can buy a single share (or more) of any of 140 large companies for a one-time set-up charge of $5 plus the market price of the stock. Also, thanks to regulatory changes enacted by the Securities and Exchange Commission last year, about two dozen large corporations (with more on the way) offer “direct purchase” plans that let you buy stock straight from them, at no commission at all.
And nearly 1,000 companies offer shareholders “dividend repurchase plans,” or DRIPs, which allow you to receive dividends in stock rather than cash, again bypassing commissions.
