Picking stocks is intimidating, but far from impossible. The stock market has really been humming along lately for stock pickers and armchair investors alike. Consider that the Dow Jones Industrial average is up 22% since September 1, the S&P 500 is up 27% in the same period, and the tech-heavy Nasdaq is up 33%. Since January 1, all three indexes are up about 6% in about 6 weeks.
But the best news of all is that this is a broad-based that isn’t just for sophisticated traders and hedge funds. This is a real rally for real folks, for hardworking Americans with 401k plans and buy-and-hold retail investors who actively manage their own small portfolios. Picking stocks clearly isn’t as difficult as it seems.
Take Dow components. McDonald’s (NYSE: MCD), IBM (NYSE: IBM), Caterpillar (NYSE: CAT) and Wal-Mart (NYSE: WMT). All are up more than 30% since Oct. 9, 2007. That’s an annualized gain well over 10% for the group when you add in dividends – great returns in any market, and even more impressive considering it’s based on buying at “peak” valuations as the stock market hit its pre-recession high in fall 2007.
And who says buying and holding blue chips is an extinct investment strategy for the timid or naive?
Certainly, there are some dogs of the Dow too. Cisco (NASDAQ: CSCO) is off -42% since Oct. 9, 2007, Alcoa (NYSE: AA) is off -52% and Bank of America (NYSE: BAC) is off -68%. And GM and AIG complete wiped out investors who didn’t bail out during the death spiral during the financial crisis.
But that’s my point – it’s a stock picker’s market, and just buying the indexes gives you a share of the worst duds and the soaring successes. For a long-term investor picking stocks with an IRA or a few thousand dollars in a brokerage account, all you have to do with your picks is focus your cash on fewer losers and more winners to beat the market.
Easier for me to say, right? Well hopefully with these five stock picking tips you’ll see that it’s not quite as daunting as some think to pick the right stocks, even in a challenging market like this one.
Stock Picking Tip #1 – Making Money Should Make Sense
Warren Buffett jokes that he isn’t smart enough to understand how many companies make their money. Whether you believe him or not, you should certainly have faith in his message – don’t buy a stock if it doesn’t seem like a good business model. (You can read 10 Warren Buffett quotes here.)
Take everybody’s darling tech stock, Apple (NASDAQ: AAPL). How does the company succeed? By creating innovative products consumers can’t live without. Unless you’ve been living under a rock you know how the iPad is a runaway success, that the iPhone remains a dominant smartphone and that the iPod and iTunes are the standard when it comes to digital music. Apple is up 115% since Oct. 9, 2007, when the Dow Jones “peaked” before the financial crisis.
It’s no wonder that 71% of AAPL stock is in the hand of mutual fund managers and institutional investors – including over 16 million shares alone in the portfolio of Fidelity Contrafund (MUTF: FCNTX). Owning Apple just makes sense.
Stock Picking Tip #2 – A Bad Rap Doesn’t Equal a Bad Investment
One of my personal favorite stocks right now is Bank of America (NYSE: BAC). Why? Well, partly because I see improving metrics that appeal to me – more borrowers making payments on mortgages and credit cards, primarily – but also because sentiment on the stock remains overly negative.
Yes, I suppose we could see a surprise glut of foreclosures or a shocking revelation from Wikileaks about corrupt executives and cooked books. But come on – BofA just posted a $1.2 billion loss due to bad housing loans, and by its own estimation will be on the hook for $7 billion to $10 billion to settle lawsuits over defunct mortgages securities. You’re telling me there’s something uglier than that lurking on the books?
Oh yeah — and despite a brief drawback around earnings at the end of January, BAC stock is up a hefty 11% so far in 2011.
There are always good stocks that are popular and bad stocks that are kicked around for a reason. But remember that a stock price is largely a reflection of sentiment. If you can make a compelling case that sentiment is unfairly dark, you may be able to scoop up a bargain on the cheap. (If you’re really interested, read my full article on why I like Bank of America
Stock Picking Tip #3 – Growth Is a Good Thing
If you don’t like to play the value game, just look at the books and use your head. Is the company growing sales and profits at a healthy clip?
Consider the profits and revenue for streaming video icon Netflix (NASDAQ: NFLX) from fiscal 2007 through estimated figures for this year:
| YEAR | REVENUE | EPS |
| 2011 | $3.13B (E) | $4.39 (E) |
| 2010 | $2.16B | $2.96 |
| 2009 | $1.67B | $1.98 |
| 2008 | $1.36B | $1.32 |
| 2007 | $1.20B | $0.97 |
Is it any wonder the stock is up a stunning 870% in the last five years, 290% in the last 52 weeks and a whopping 40% year-to-date in 2011? The company is growing steadily and impressively with no end in sight. While there’s always the threat of an upstate competitor that changes the game with a new technology or cheaper and faster service, for the time being it seems like Netflix numbers can’t go anywhere but up.
Stock Picking Tip #4 – Diversify, but Don’t Ignore Sector Rotation
While every buy and hold investors should keep an eye out for diversification, there’s nothing wrong with a few sector bets here and there. For instance, consumer staples stocks like Walmart (NYSE: WMT) and Coca Cola (NYSE: KO) hung tough in the worst of the recession. Both blue chip stocks have significantly outperformed the market since 2007 thanks in large part to the fact they took a much smaller hit during the downturn.
Of course, WMT and KO stock have both lagged the market considerably in 2011 now that consumer spending has ticked up and business spending on IT has been strong. Instead, technology stocks have seen a surge across late 2010 – with Apple (NASDAQ: AAPL), Google (NASDAQ: GOOG) and even IBM (NYSE: IBM) scoring gains of more than 30% since September 1.
While long-term investors should never chase short-term fads, there’s nothing wrong with paying attention to broader trends that favor specific sectors and the adapting when the economic conditions change again. Read
Stock Picking Tip #5 – Don’t Get Greedy
At the end of the day, every investor is out there to make money. But the pursuit of wealth should not lead you to take undue risk. Beating the market by a modest amount is something you can realistically shoot for if you do your homework – but don’t expect to double the gains of the S&P 500 without taking on massive risk or aggressive bets.
I did a quick screen on mutual funds that get four-star or five-star Morningstar ratings and have outperformed the market significantly over the last five tumultuous years on Wall Street. Nearly all tallied just two or three percentage points better than the Dow Jones – with the only two exceptions being the Asia-focused Matthews China Fund (MUTF: MCHFX) and the Tocqueville Gold (MUTF: TGLDX). While investing in gold and emerging markets are surely a good idea for any investor, it’s a dangerous game to take your entire nest egg and go “all in” on these two volatile funds. If the pendulum swings the other way unexpectedly, you could lose everything.
So be responsible. Seek out logical investments, either in value stocks that you think have a bad rap and value pricing or growth stocks boasting a strong upward trend. Diversify, but don’t be afraid to lean towards the opportunity.
While these simple tips can help you beat the market, they’re not rocket science and they’re certainly not innovative new ideas. I’ll admit that if significantly outperforming the indexes over the long-term was this easy then we would all own our own hedge funds.
But that doesn’t mean you have to settle for tracking the Dow or S&P 500 – even in a stock picker’s market like this one. By doing your homework you can tack on an extra few percentage points of returns to your IRA statement.
And over a decade or two, that could make quite a difference.
Jeff Reeves is editor of InvestorPlace.com . As of this writing, he held a long position in Bank of America stock. Follow him on Twitter or write to him at investingwithjeff@gmail.com.
