In this entry, I’d like to get right to the nitty-gritty of how I pick stocks. In some ways, this approach can be a lot of fun — it gives you a chance to think about you investments as companies that do things, and not just as stock certificates that up and down in value.
The following are some of the Peter Lynch principles that have guided my choice in stocks:
1. Invest in companies we already know.
2. Behind every stock is a company — find out what it’s doing.
3. Owning stocks is like having children — own only the number of stocks you can tend to.
a. We don’t need more than five companies in our portfolios.
b. Know what we own and why we own it.
4. Investigate a company’s financials before investing in it.
More details after the jump.
I invest in companies I know
For the majority of my working career, I worked in high tech companies — so that’s the industry I know best. Most of the stocks in my portfolio are high tech stocks. In a way I have an advantage, because often it’s the high tech companies that are the innovators — a primary characteristic of the companies I buy. That said, I like workhorses, too — like IBM and Texas Instruments.
Research, research, research
With the internet, research is easy — so I do it. I don’t invest in companies I know nothing about. Scottrade houses my portfolio and I use their service to buy and sell stocks. They also have a great research library which I explore all the time. When I think how much time I used to spend in a library groping through paper data that was outdated before it was printed. Today so much more information is available to me right at my fingertips 24/7. It’s a great world.
Choose a limited number of stocks to tend
While I love investing, I do have other things to do. To manage the research — and the emotional angst at times — I limit the number of companies I invest in at any one time. In my heyday, maybe, I invested in ten or twelve companies. Today, I rarely have more than five companies in my portfolio. I’d rather own a lot of shares in a couple of companies that I really like and trust, than invest in more companies than I can manage.
Investigate the financials
This is what I do best. These days I invest in companies that are making a profit. In early years, I took some chances on startups and young innovators, but now that I’m into retirement, I like established companies who know what they’re doing and are doing it well.
(Tip: You can get a current snapshot of these numbers by putting a stock ticker symbol into the search at finance.yahoo.com among many other places on the Web. Enter AAPL, for instance, to see Apple’s numbers.)
The price/earnings (P/E) ratio is important to me. (To get the P/E, you divide the price of a share of stock by the earnings per share. If the stock is $40 and it earns $2 per share, that’s a P/E of 20. If the stock is $1000 and it earns $.50 per share, that’s a P/E of 2000.
I like reasonable numbers here. If a company’s price is out of sync with its earnings, I proceed with caution — and often choose to pass on it. I’ll talk more about this in a later blog.
Earnings per share (EPS) is important to me, too. I like big numbers here. A solid EPS is as comfortable to me as a down blanket.
Growth rate is not that important to me, although it’s important because it often drives the stock price. But, a company making $5.00 a share is not going to grow as quickly as a company making $.05 a share. It’s just a fact. But, unlike Wall Street at times, I like the $5.00 a share return better than the $05.
I also like companies that have little or no debt and lots of cash. I just do.
And, today, I often choose companies that pay dividends. Again, I’m in retirement — and I like the income. When I was younger, I didn’t much care. In fact, a company with a dividend felt a bit old and stogy to me. Not anymore but maybe’s it’s because I’ve become old and stoggy.