Investing in Individual Stocks and Stock Mutual Funds: The Basics

By now you probably have a good idea of what percentage of your portfolio should consist of stocks. Next you can get more detailed and learn how to build that stock portion of your pie. We'll start with the basics of investing in stocks in this chapter; then in Chapter 4 we'll look in detail at choosing the best mix of sotcks for your portfolio.

 

One Team or the Whole League? Individual Stocks and Mutual Funds

Suppose it's the start of the football season. Everybody knows that come January, only two of those 30 NFL teams will be playing in the Super Bowl, which will have only one winner. So maybe you try to pick the winner, the 49ers have a good shot at it, you say, or maybe the Chiefs, maybe Temapa Bay

 

 

Look for quality: Earning per share

My first criterion in looking at individual stocks is quality. Therefore, I look for a healthy, thriving company, meaning one that's doing well financially, with above-average earnings growth and reasonable debt. as we've said, a company is made to grow, so I always ask some questions: Is management quick and adaptable? 

Does the company create a product contemporary? Who's the competition? However, at the end of the day, all of these things need to show up in the numbers.

The quality of a stock can be measured in a number of ways, but probably the most popular is the company's earnings trend. A company's earnings are its net income or profit, often called its bottom line.

Because company earnings are usually given in millions of dollars, it's handy to break that figure down to a smaller number, called earnings per shear (EPS), which are the company's total earnings for a period divided by the number of shares outstanding. For example, a company with $50 million in earnings and 20 million shares outstanding woudl have earnings per share of $2.50.

 

That number has meaing only if you can compare it to earlier EPS numbers. A downturn in a year or a quater due to special company problems or general economic change may be insignificant, but ideally you expect a company's EPS to increase over time. After all, you buy a stock today for a share in its future growth. In fact, when you look at long-term sotck returns, it becomes clear that the companies with the strongest earnings growth also have the best long-term returns. in the short term, the stock market can be overly reacitve and errativ, but in the long term, it's earnings that count.

 

Strong earnings momentum is likely to be shown by younger, growing companies. More established quality companies will make slight improvements over various quarters, but such a company is more likely to be branded as a company with "Stable earnings." There's nothing wrong with stability.

 

As a young investor, I used to search for companies with accelerating earnings by circling earnings announcements in the Wall Street Journal. Today stocks are routinely ranked by comparing earnings to expectiations and historical trends. The principle is the same: But stock in companies with accelerated earnings early, and continue to monitor their performance to see if the trend continues.

Stocks with improving earngings and accelerating prices are momentum stocks, and they're solid investments as long as earnings outpace price. William J. O'Neil popularized momentum investing through his newspaper, Investor's Business Daily. Its price strength, and other information for momentum investors.

 

From Charles Schwab's Guide to Financial Independence: Simple Solutions for Busy People.