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Buying Individual Stocks - Learning

As with any activity you're interested in pursuing, if you plan to buy stocks individually for your investment portfolio you will want to learn as much as you can about it. You'll be best served by regarding this process as an ongoing one whereby you continue reading and study so as to add to your knowledge and skills over the years.

Looking for Value:

People who do well in building wealth (AKA, their net worth) seem to have-a-nose for value. Among the options available to them, they're able to recognize what has value and what doesn't, and then put their money toward what does. This ability probably has to do with learning experiences becoming integrated into their normal thinking patterns related to how they go about assessing possibilities. They've learned measures and criteria they can consciously apply to buying and selling whatever they are considering. It's not a mystery of some kind; it's something to be learned.

If you plan to be an investor (as opposed to a short term stock trader) this notion certainly applies to buying stocks individually for your portfolio because you'll want to know whether or not the stocks you are considering represent a value. That question can be and ought to be assessed at a number of different levels, current price being one of them.

Stock Pricing:

Stock prices are determined by a truly capitalistic open market. Millions of people and institutions are involved in buying and selling stock every market day. For any one stock, if there are more buyers than sellers, the price rises; and if there are more sellers than buyers the price drops. So in one sense you can say that the value of a stock is whatever the market determines it to be at any point in time; end of story. Some knowledgeable people say that "the market" takes into account any and all news and the current circumstances of listed companies almost immediately, that everything of importance is reflected in the price, and it is therefore logical and efficient. Maybe so. But maybe not.

Market Efficiency:

Maybe not since stocks are bought and sold by human beings and anyone who claims humans are always logical or efficient clearly hasn't met any of the people I've known through my entire life. A lot of what happens with the markets often looks more like mob psychology than anything else. At times people seem to buy what everyone else is buying and sell what everyone else is selling; like sharks in a feeding frenzy in the one case and rats abandoning ship in the other. Periodically this happens for no sound reason at all-other than simple greed, I guess-and then you get market conditions like the dotcom bubble of the year 2000, the bubble in gold prices in the early 1980s, or the tulip bulb bubble in Holland way back when. During bubbles, the prices paid for something (whatever that something might be) get way-way-way out of line with the basic value of the item.

The stock of a particular company, and even a whole industry, can become in or out of "favor" as expressed by its current market price. A stock "in favor" may have buyers clamoring to buy shares even though the business represented in the stock isn't doing that great, and a stock "out of favor" may find few buyers even though the business is doing fine.

So I suspect it's fair to say the market as reflected in stock prices ISN'T always logical and efficient, and that it IS always somewhat inefficient and illogical with respect to some companies. There's opportunity here if we can find which companies are inefficiently and illogically valued by their current market price. To do that, we need to use value measures other than price alone. We need to find measures that help place a value on the company underlying the stock being considered so we can make decisions about whether the company is being overvalued or undervalued by the market.

This is where LEARNING (capitalized, bolded, underlined, and colored for emphasis) enters the picture. You'll want to learn about how to use assessment tools such as price to earnings ratios, debt ratios, book value, dividend yield, and how to read and understand a company prospectus. It isn't my intention to cover all these areas in detail here, but to point you toward a pathway for your self-education.

Resources for Learning:

In this computer age, there are many resources online for information about investment approaches and about valuation of stocks for someone who is in a learning mode. A Google or Yahoo search for related terminology will yield thousands of informational websites. Two that I find useful are www.investopedia.com and www.valueline.com.

A print or online subscription to Barron's or The Wall Street Journal might also be a fine idea. They're both plain old good newspapers first of all, and the finance related information in them will be valuable in your self-education enterprise.

If you're planning to buy stocks individually, you might as well learn from the best and most successful investors; people like Benjamin Graham, Warren Buffett, and Peter Lynch. They've all written books detailing something of how they go about evaluating investment opportunities.

Peter Lynch is the legendary, and now retired, former manager of the Fidelity Magellan mutual fund. During his long tenure in that role, he built Magellan into a huge and hugely successful fund that out performed the stock market averages virtually every year.

Everybody knows at least something about Warren Buffett. For years he was probably the richest man in America (until Bill Gates and Microsoft came along) and he earned his money through investing in the stock markets. Mr. Buffett may well be the most successful investor of all time.

Benjamin Graham was Warren Buffett's mentor and taught him much of what made Mr. Buffett successful, including how to evaluate companies to find businesses that are good businesses and also good investments.

You can "Google" these names for information on the internet, and you can find their books at your local books store or through Amazon.com.

Summary:

The high priced stocks everyone is recommending and buying aren't always the best value and neither are the lower priced stocks. The sexy, out-on-the-leading-edge stocks aren't always the most profitable. The mundane definitely un-sexy stocks might not be profitable either. We need to look at more than price alone and look beyond what's sexy or not.

If you're considering buying that shiny red Corvette (I love Corvettes) the guy across town is selling at a bargain price, it might be a good idea to look under the hood to make sure it's got an engine to push it along into the future.

It's important to learn how to evaluate companies, even if you don't plan to do all of your own research, so you can clearly understand what your broker is telling you and figure out whether or not it makes sense related to your overall investment program plans and goals. And if you're going to buy and sell stocks individually, it's a good idea to learn from really successful investors.

arley