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January 8, 2010 4:36 PM   Subscribe

What are some really, really basic rules of thumb for picking (or avoiding) stocks?

Quick background: I've just started investing. I'm in my mid-20s with a stable job and no debts. I've opened a Roth IRA which I will maximize annually, and have 6 months expenses saved away, with plenty left over to play with.

For the last month, I've been playing with stocks mostly for fun. I don't have the time or interest to get heavily involved in analytics, but I'm okay with glancing at a balance sheet, or reading an article here and there.

What are simple rules that aren't perfect, but will give me a slightly better chance of making a modest return?

Here are some made-up examples:

1. Look for stocks with a P/E of < 20.
2. Don't buy during a spike, or sell during a plummet.
3. Look at X value in the balance sheet. If it's Y, then don't buy.
4. If you ever reach a 7% return, just sell.

Since this is mostly for fun, I'd prefer rules that help with more exciting short-term investments, but I'm certainly not opposed to long-term strategies.
posted by TimeTravelSpeed to Work & Money (26 answers total) 19 users marked this as a favorite
This is really really basic, and I haven't implemented it yet....but it is advise that was given to me so I'll pass it on nonetheless...

Check for items that everyone uses...stuff that is normally taken for granted.

For example, if you look in almost any public restroom, you will see all of the toilets, urinals, and sinks are all made by American Standard.
Another example is the majority of cash registers in stores are made by the same company....don't remember the name though.

This indicates a company that has been in business forever and will most likely not lose much business over time. They will probably steadily but SLOWLY gain.

Not sure if this is exactly the kind of thing you're looking for....but it's something.
posted by AltReality at 4:44 PM on January 8, 2010

Over the long haul, chances are you will not beat the market. Buy index stocks.
posted by downing street memo at 4:44 PM on January 8, 2010 [1 favorite]

Buy utilities. People will always need to flush their toilets.
posted by DarlingBri at 4:46 PM on January 8, 2010

- Don't try to time the market. At your age you have plenty of time to let your stocks go up and down many times.

- Index funds are safe, but are probably a bit conservative for you at your age.

- Take all of this and everything above and below with a grain of salt.
posted by Gerard Sorme at 5:00 PM on January 8, 2010

This is all terrible advice (except downing street). If it were that easy, don't you think people would be getting rich all over the place? There is no strategy easy strategy or rules to beat the market, not even by .00001%.

Buy an index fund and forget about it, or if you like gambling, pick stocks at random. You'll do just as well picking randomly as you would with any strategy outlined above, or below I'm guessing.
posted by lohmannn at 5:03 PM on January 8, 2010 [1 favorite]

What are simple rules that aren't perfect, but will give me a slightly better chance of making a modest return?

Define "modest" and define your horizon for making a return. Today? This year? This decade? Strategies will shift significantly depending on these definitions.
posted by Cool Papa Bell at 5:07 PM on January 8, 2010

It is not that simple.

There are strategies, but no basic "rules of thumb" like what you want.

I would check into some Warren Buffet stock screens, like what this article describes, or this one.
posted by charlesv at 5:10 PM on January 8, 2010

Hi. What's a really simple rule of thumb for (insert task that lots of really really smart people with tremendous financial incentives struggle all of their life to do just slightly better than what could be achieved by just indiscriminately buying everything - and even then most fail)
posted by JPD at 5:19 PM on January 8, 2010

Read A Random Walk Down Wall Street. Figure out how much money you don't mind spending on fun for yourself. Put your savings, minus your fun money, in a well-diversified index fund with zero or low fees. Then use your fun money to buy and sell stocks via a strategy that seems convincing to you. Continue until your fun money is all gone. You will have plenty of fun, and your desired modest return.
posted by escabeche at 5:24 PM on January 8, 2010 [1 favorite]

If it is money that you are playing with for fun:
buy stocks in a firm/industry that you are interested in. Having a bit of 'ownership' will likely make you more aware of how much they change, and you can start to figure out how much of it is random, or conversely what real events can affect them.

If it is money you are storing and growing for the future:
buy index funds.
posted by jacalata at 5:26 PM on January 8, 2010

I just turned in the "investing" chapter for my upcoming book on personal finance, but I am not a finance professional. That disclaimer aside: Buy index funds.

The fact that you're asking this question at all should be a clue that you're not ready to trade stocks. What you're wanting to do is speculate, not invest. There's a difference. Speculation is like gambling, and it has the same long-term results.

Investing, on the other hand, is a methodical approach to the market where you're not trying to make your money by outsmarting everybody else. Which is good, because you can't.

Some things to consider:
  • You are not a professional investor. (In fact, you're a raw novice.) What makes you think that you're going to be able to start trading and out-think the pros? Because the pros are who you're trading with. Something like 80% of the money in the market is managed by a professional manager. When you buy and sell, you're buying and selling with somebody who knows more than you do. Is that what you want to be doing?
  • The kind of stuff you're suggesting is a loser's game. Study after study has shown that the most important predictor of long-term investment returns are costs. This is true whether you're trading stocks or mutual funds. And if you're trading often, you're incurring more costs, putting you further and further behind.
  • If you're investing for excitement, you're doing it for the wrong reason. Again, you're treating it like gambling. You're speculating. And if you're doing this for fun, that's fine. But it sounds like you're doing this with money in your IRA, and money in an IRA is not there to have fun with. It's there to keep you comfortable in old age. It's there to help you in retirement.
My suggestion is to turn off the computer and walk to your local library to check out some books about investing. I'd recommend anything by John Bogle, Burton Malkiel, or William Bernstein. But I think my favorite recent book may be How a 2nd Grader Beats Wall Streat by Allan Roth (no relation). The premise (that Roth's 8-year-old son can beat the pros) is a little twee, but the book's advice is spot-on.

But I think the important thing for you to understand is that success in the short term is basically luck. There are no proven systems that are going to give you consistent results over the short term. And over the long term? Well, think about this:

Since 1926, the stock market has returned an average of just about 10% per year (before inflation and taxes). (And please note that's the average, and average is not normal -- there have only been two out of the last 80 years that came close to 10%; most years are -40% like 2008 or +25% like last year.)

If the market, as a whole, returns 10% a year, then index funds -- mutual funds designed to track the market -- also return 10% a year. (They actually return a tad less due to tracking error, but let's not get into that.) And if passive investing with index funds returns the average, logic (and the relentless rules of humble arithmetic) dictate that active investing also returns 10% a year. That is, if you remove a sample from the whole, and both have the same average, then whatever's left over also has the same average. Right?

So, both passive investing and active investing get you 10% before taxes and inflation. That's great, right? Well, hold on. Passive investing with index funds costs you about 0.20% per year. Active investing, on the other hand, is expensive. What it costs you to trade stocks is of course dependent on how often you trade. But with mutual funds, the average expense ration in an active fund is 1.3%. Plus active funds have roughly another 0.7% in transaction costs -- for trading, just like you're going to do. With an active fund, you give up 2.0% per year.

Based on this info, you can calculate that the average active fund typically returns 8.0% before taxes and inflation, while the average index fund returns 9.8%. That 1.8% may not seem like much, but it's huge. Huge. Compounding kills you in the long run.

Anyhow, your question makes me believe you don't grasp some of the basics of investing, such as diversification, asset allocation, and so on. There's no shame in that. Five years ago, I was in the same boat. I, too, wanted to pick stocks. I lost a lot of money doing that, so I read books. I'm glad I did.

Again, I highly recommend you high-tail it to the library instead of taking investment advice from folks on the internet (even me). You may also want to spend some time watching Michael Fischer's excellent Saving and Investing videos at YouTube. They're not flashy -- in fact, they're pretty dull -- but they contain excellent info. You may also want to browse my investing archives at Get Rich Slowly, though that info isn't very organized.

I'd tell you to pick up a copy of Your Money: The Missing Manual and read the chapter on investing, but the book isn't finished yet. However, if you send me e-mail at jdroth/foldedspace.org, I'll send you the very rough draft of the investing chapter, in which I give a lot more info on this subject.

If you want to have fun picking stocks, just do a simple stock-market game or track stocks in a faux fund. Don't use your real money. That's your money for when you're old and can't work anymore. Don't gamble it on gimmicky systems. It's a recipe for tears.
posted by jdroth at 6:19 PM on January 8, 2010 [7 favorites]

Here is the only rule of thumb you need. Seriously.

If you need to ask about rules of thumb for picking stocks, you aren't ready to pick stocks. Buy broad based mutual funds.
posted by Justinian at 6:23 PM on January 8, 2010

So after my long rant, I re-read your question. (That should be the cardinal rule of AskMe!) It sounds to me as if maybe you are being sensible with your IRA, and you're just looking to play with your "extra" money. In that case, take away all my rants about saving for your future.

I still think your best bet is just to stick the money in index funds, but if you really want to play with it, then pick up a copy of The Intelligent Investor by Benjamin Graham. Also good are Stocks for the Long Run by Jeremy Siegel (he goes over all sorts of different methods and compares them, which sounds like exactly what you want) and Million Dollar Portfolio by David and Tom Gardner, the motley fools. (Speaking of which, you'd be better off asking this question at The Motley Fool, anyhow.
posted by jdroth at 6:24 PM on January 8, 2010

If you are playing with money for fun, then you are not investing. You are gambling for entertainment. You would be better off going to Las Vegas for fun and it will be cheaper in the long run.

If you pick a few stocks you are taking on unnecessary unsystemic risk. You can diversify away this risk by using low cost index funds. Start here at the Bogleheads forum.
posted by JackFlash at 6:28 PM on January 8, 2010

My own semi-dismal experience:
Finding and buying a winning stock (undervalued, unnoticed by the 'market'): Not so hard.

Selling that stock (note: this is the only time you actually make money): requires constant attention--big pain in neck, and not fun.

Company get bought by another company that noticed undervalued stock, giving you a return on the stock comparable to what you would have gotten by leaving the money in a bank CD: welcome to my world.

Just remember--you are swimming in the shark tank, armed with good intentions.
posted by hexatron at 6:48 PM on January 8, 2010

Just remember--you are swimming in the shark tank, armed with good intentions.

I think this is an important point that a lot of the general public misses. The stock market isn't a bunch of people all cheering for you to make money. The stock market, when it comes to options and individual stocks, is a collection of sociopathic Patrick Bateman types fueled by coke binges and greed whose purpose in life is to separate you from your money as rapidly as possible. And if that means breaking the economy in the process, well you can't make an omelette without killing a few people.

Index funds or broad based mutual funds are where to go when you're starting out.
posted by Justinian at 7:30 PM on January 8, 2010 [1 favorite]

Seconding escabeche. Try reading Fooled By Randomness (Taleb) for a good perspective on why picking individual stocks or choosing some popularized strategy really will not benefit you, and then A Random Walk Down Wall Street for what you should be doing (which is probably index funds).

If you really want to pick stocks, Graham & Dodd's Security Analysis is a classic book to read to understand why its very hard to do this well.
posted by devilsbrigade at 8:28 PM on January 8, 2010

There are no simple rules for picking stocks on an individual stocks. Love or hate Jim Cramer (and I go both ways) his rule for picking individual stocks is that you must be willing to spend one hour a week per stock on any individual stock you're looking to purchase.

Or wait for huge changes in the market. My wife and I have actually invested a few extra dollars in some pretty solid stocks when the market seemed to bottom out around around 7-8 k (we actually waited for the market to come back about 1000 pts before buying). These stocks have all done pretty well (except 1 and thats GE which is only down a small amount).

Otherwise buy low, sell high.
posted by bitdamaged at 9:12 PM on January 8, 2010

Since you mention you have a Roth IRA invested in an index fund and ample savings, it seems you're pretty financially disciplined. It looks like you're just trying to find some rules to bound how you play with your discretionary "mad money." Any of Graham's rules for defensive stock selection would qualify I think:

1. P/E Ratio less than 15
2. P/Book Ratio less than 1.5
3. Book Value more than 0.01
4. Current Ratio more than 2
5. Annual EPS Growth (5-Yr Avg) more than 3%
6. 5-Year Dividend Growth more than 0%
7. 5-Year P/E Low more than 0.01
8. 1-Year Revenue more than $400 Million

(These aren't the exact rules in TII, but modernized versions.)

For shorter term, there's also the whole field of technical analysis. Look up Ascending Triangle for an illustrative example of a technical method.
posted by mnemonic at 9:24 PM on January 8, 2010 [5 favorites]

There are no simple rules. If there were, everyone would be following them and they'd get cancelled out ... after all, you need someone on the other side of every trade.

If you're willing to put some time into learning the ropes, a good start would be William O'Neil's "How to Make Money in Stocks". He's a bit of a crazy old-timey Republican but he knows what he's talking about in the world of stocks, and I'm only one of many people who have profited from using his methods.
posted by dacoit at 9:40 PM on January 8, 2010

Here are the simple rules:

1- Have two different strategies. One is long term growth of your assets.
2- The other is "playing the market". This is almost exactly like parimutuel betting.
posted by gjc at 7:45 AM on January 9, 2010

Here are my rules for play money investing accounts:

1) Never use margin.
2) Never sell short.
3) Never mess with options.
4) Don't let the account get too big.

In my experience, those are easy ways to get in over your head, especially if you aren't watching the market every single day. There's a difference between having a fun account of $5k that goes up or down $500, and having one that goes to $0.
posted by smackfu at 8:01 AM on January 9, 2010

You may want to look into DRIPs too.
posted by jmmpangaea at 11:46 AM on January 9, 2010

Thank you for the suggestions. I'm getting loud and clear the "just don't buy stocks" message, and will get my money into a fund sooner because of it. So, thanks.

One thing I don't think I made clear, though, is that I already am working on my long-term investment plan. I'm placing the bulk of my leftover cash into an index and leaving it alone. I'm maxing out my Roth, and have 6 months of expenses buried away. (See the 129-word investment book "Dilbert's Unified Theory of Everything Financial" which admittedly says to avoid stocks).

But I'd also like to try something risky while I'm young. I have no delusions of "beating the pros", nor any interest in trying, but surely there are some signals to look out for when considering buying shares in a company?

I'm certainly not against advice saying to avoid stocks, as long as it's understood that it's with a very conservative amount of money outside of an otherwise low-risk investment plan.
posted by TimeTravelSpeed at 11:52 AM on January 9, 2010

It sounds like you have a sound investment plan and know the risks, but don't be that guy that says he just smokes on social occasions and ends up a three pack a day smoker. Stock trading is addictive entertainment and perhaps the worst thing that can happen is that you get lucky on your first trade. Pretty soon you are trading your various index stocks just like your fun money. Many people mistake luck for skill but luck always runs out.
posted by JackFlash at 2:47 PM on January 9, 2010

JackFlash, you ain't kidding. The first few weeks of doing this felt a lot like watching the daily polls during the 2004 and 2008 elections in that my mood each day was basically dependent on how well my portfolio was doing. And like you said, I was pretty thrilled and encouraged early on as I was doing quite well. But my success didn't continue so I quickly snapped out of that high and into the reality of risk.

Now I'm more grounded and less enthused, trying to find ways to do this smarter (if there are such ways). I may read a book on the subject of picking stocks, but I'm not really not anxious to get into that world. Frankly, I don't see myself keeping interest for more than a few months or so. It's already pretty draining with little instant gratification.
posted by TimeTravelSpeed at 6:50 PM on January 9, 2010

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