Stock tips spill from everywhere: on social media, on TV, at parties, in the gym. Email boxes are full of pitches for can’t-miss moneymakers to buy right now. Even your own scouting efforts spot stocks whose solid growth seems like solid gold.Pick any stock and someone will be able to spin a story about why it’s a great opportunity.But when you are interested in investing in stocks, here’s what you need to know.
Here are two buying tips from the pros:
Compare a stock’s price to its expected earnings-growth rate. The price-to-earnings-growth ratio, or “PEG,” should be at or close to 1.0.
For example, a stock at 30 times earnings might seem overpriced if the average company in the industry commands a price-to-earnings ratio, or “P/E,” of 20. But if analysts expect 30% earnings growth for the company over the next year, a PEG ratio of 1.0 is eye-catching.
“It’s the biggest metric we look at,” said Alec Young, a global equity strategist at Standard & Poor’s. “A company may have a high P/E, but, until you know what the earnings growth is, it’s hard to ascertain whether the stock is attractive or not.”
Also, study the corporate balance sheet, a financial summary that — along with the cash-flow and income statements — reflects the quality of earnings. These documents tell you whether management makes, spends and invests shareholders’ money wisely. Company websites should post 10-Q quarterly reports and 10-K annual reports, or the Securities and Exchange Commission websiteoffers these and other informative disclosures.
What to WATCH OUT for
Overpriced goods: Cost matters. Purchase price, more than the selling price, determines return on investment. Be cautious about highfliers that may be closer to the end of their runs than the beginning. That sports drink you can’t get enough of, for instance; the market probably knows it’s a top seller and has bid up the stock accordingly.
You could invest in the best company, but if you’re overpaying for it, you could end up losing money because the stock price already reflects the reason you’re buying the stock.
Hunches and headlines: Good companies aren’t always good stocks, and basing decisions on hunches and headlines is not an investment strategy. Don’t make investment decisions solely on one or two sentences of hype. Relying on unsubstantiated claims, rumors and online tips — or your next-door neighbor — is a mistake.
Leave impulse buying for the supermarket and out of the stock market. Have patience. Time gives individuals a rare edge over short-term-minded institutions and hedge funds, which tend to trade frequently. Longer investment horizons smooth the ride down Wall Street and make market losses less likely.
‘Pump and dump’ scams: As the old saying goes: Look around the poker table; if you can’t see the patsy — you’re it. With stocks, the players at the table are internet chat rooms and bulletin boards, spam email, investment newsletters, and even television and radio.
Whatever the delivery method, the classic “pump-and-dump” contains the same message: Buy this stock now, before everyone learns about the firm’s newest widget. The stock usually is thinly traded on the less-policed over-the-counter market, also called the Pink Sheets.
If you and others like you buy into such a pitch, your demand will only boost the stock price, turning a tidy profit for those who bought in earlier than you — often the very folks pumping the stock — who then sell, tanking the shares and leaving newcomers with big losses.
Don’t take the bait. It’s tough to be skeptical when you’re told what you want to hear, but doing otherwise puts you at risk of being separated from your money by fraudulent promoters.
Love-struck stocks: Falling in love with a stock can bring reward, satisfaction and visions of a long-term relationship. Trouble is, a stock won’t love you back. If shares head south, you have to be ready to break it off and sell.
Stay disciplined and diversified. Have a philosophy that you stick to that can be easily replicated and consistently applied. Don’t waver.
And it’s not just about one stock. Many successful investors recommend having about 20 to 25 stocks in a personal portfolio. It doesn’t matter how well you think you know a company. Anything can happen.
Climbing on bandwagons: Many people buy stocks but aren’t stock investors. They want the Next Big Thing — the stock that will make them both rich and smart. In fact, the next Microsoft MSFT, +0.35% or Google GOOG, +0.29% is out there; it’s just unlikely you’ll find it first.
Instead, do these things:
- Buy into companies with a history of superior earnings
- Buy into companies with barriers to entry so they can continue to earn superior returns
- Buy into companies with a track record of making wise capital-reinvestment decisions.