Know What You're Buying, Buy What You Know
One of the benefits of being a consumer is that you are called on to evaluate products and services every day. You have learned that you can get the best results by thoroughly researching your options before you make a purchasing decision. Maybe you've recently purchased some new electronics that you just can't put down, switched cereal brands to cut some of the sugar out of your kids' diet, or started a new medication that actually made you feel better without any side effects. These are experiences you can put to work when you're making your investment decisions.
Your observations are another way to gain valuable insight. During your recent trip to Japan, did you notice people consuming huge quantities of a new Coca-Cola product? While waiting to pay for dinner at your favorite restaurant, did you notice that many of the patrons pulled out American Express cards? Part of doing your homework as an investor is noticing the companies whose products and services are prominently displayed and used by the people around you.
Putting serious thought into your investments early on will most likely pay off in the long run. Unfortunately, many people are introduced to the world of investing through a hot stock tip from their barber, buddy, or bellman. There's really no way to make an easy buck, and by jumping into a stock because of a random tip, you'll probably end up losing money.
Another huge consideration when buying stocks is price. Would you pay any amount to buy a car or a house? Probably not. Most people like to feel that they've gotten a good deal. They're looking for a price that's proportionate to their buying budget and what they get from the purchase. It's the same with stock investing: The price of a particular stock is a critical part of the buying and selling equation. Taking a business attitude toward stock buying is important — it is wise to base your investment decisions on a variety of factors, including purchase price. That's the only way to ensure profitability in the long run. You want high quality at a fair (or better than fair) price.
Fortunately, good-quality companies in this country are plentiful. Finding these companies, however, is something of a challenge. Some investors are more inclined to look for the current hot stock, while others prefer to hunt out a great deal. The terms growth investing and value investing describe these differing approaches.
According to a special report put out by Wells Fargo, large company stocks have brought in average annual returns of 11.3 percent since 1926. Compare that with a 12.6 percent return on small company stocks and just 5.6 percent on long-term corporate bonds over the same period.
Essentially, growth investors want to own a piece of the fastest-growing companies around, even if it means paying a hefty price for this privilege. Growth companies are organizations that have experienced rapid growth, such as Microsoft. They may have outstanding management teams, highly rated developments, or plans for aggressive expansion into foreign markets. Growth-company stocks rarely pay significant dividends, and growth investors don't expect them to. Instead, growth companies plow their earnings right back into the business to promote even more growth. Among other things, growth investors pay close attention to company earnings. If growth investing fits in with your overall investment strategy, look for companies that have demonstrated strong growth over the past several years.
Value investors are on the prowl for bargains, and they're more inclined than growth investors to analyze companies using such data as sales volume, earnings, and cash flow. The philosophy here is that value companies are actually undervalued, so their stock price doesn't really represent how much they're worth. Value investors are often willing to ride out stock price fluctuations because of the extensive research they have done prior to committing to a particular stock.
Get the Facts
Both styles of investing can be lucrative. The idea is to figure out which style of investment better fits your personality and investment strategy. Sometimes you may lean toward growth investing; other times, you may feel that taking a value-investing approach is the way to go. Still other times you may want growth and value all wrapped up in one neat package. In that case, you would be looking for growth at a reasonable price, known in industry lingo as GARP.
Every investor should use a research checklist to evaluate stock under consideration. Look for annual reports, financial statements, industry comparisons, and current news items. Analyze your findings before making investment decisions. Once you become a shareholder, you will find that your main information needs are filled with press releases, ongoing financial statements, and judicious stock price monitoring.
Whichever style you choose, you need a place to get the information on which you can base your decision. These days, there's no better starting point than the Internet. On the web, you can easily find the best investment information in real time, mostly for free. More and more, investors both young and old are turning to websites to limit their reliance on expensive financial advisors. In addition to the prospect company's web page, there are dozens of sites that provide in-depth company data and even more that offer real-time stock quotes.
There is no shortage of good market research available to you as an investor. Part of your job is to determine which sources work best for your needs. You can find a listing of trusted investment sites in Chapter 17.