Newspaper article Sarasota Herald Tribune

Does It Make Sense to Buy Umbrella or Sunglass Shares?

Newspaper article Sarasota Herald Tribune

Does It Make Sense to Buy Umbrella or Sunglass Shares?

Article excerpt

AT TIMES I BECOME PESSIMISTIC about the way some investors select stocks. It often seems to be an almost random process rather than a well-defined methodology. They don't appear to follow a set of rules or guidelines. More often than not, it seems they do little or no research before buying a stock after they hear about it on a financial television show, read about it in a financial publication or simply hear about it from a friend.

This is a prescription for poor returns.

While no investor makes only winning trades, with a little work, investors can both improve their returns and minimize the number of trades that have large losses.

Let's look at some guidelines that can help investors accomplish these goals.

The first thing an investor should do when considering a stock is to ask: "How does it fit into my existing portfolio?"

This means, for one thing, is it essentially duplicating an already existing stock? For example, if the portfolio contains a company that makes raincoats, does it make more sense to add a company that makes umbrellas or one that makes sun glasses? The former is likely to behave similarly to the raincoat company, while the latter will likely diversify the portfolio and go up when the other goes down.

The next thing an investor should ask is not, "How much can I make?" but, "How much can I lose?"

Loss control is a critical part of stock selection.

A key way to do this is to review the company's financial statements and its credit rating by, for example, Standard and Poor's or Morningstar. A company that's rated "A" is significantly less likely to run into financial problems or go bankrupt than one rated "D." Investors should understand that once a company goes bankrupt, stockholders are likely to lose their entire investment.

Additionally, an investor should consider the stock's price-to- earnings ratio (P/E), what it is relative to the market's P/E and relative to the stock's historical P/E. The higher these ratios are, the more likely the results of the trade will be disappointing.

The next thing an investor should ask: "Am I paying a reasonable price for the stock."

According to the "efficient market hypothesis," all stocks are priced at their "correct" value, based on available information. …

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