Selecting Stocks
Stock Selection is THE MOST IMPORTANT part of the Automatic Investor strategy. If you are investing for the long term, you must choose a high-quality stock. While the Automatic Investor technique will work with any stock, the risk to your capital is dependent on the quality of your choice. The higher the stock's quality, the lower the risk.
Of course if you are aware of the risks, you can use Automatic Investor to manage second tier stocks, or even speculative penny stocks. Automatic Investor is a portfolio management tool. What you put into it is entirely up to you.
We do, however, recommend you use high-quality selections - because we feel that capital preservation is paramount.
For an excellent overview on the fundamentals of selecting stocks, we highly recommend Benjamin Graham's classic book, "The Intelligent Investor"
(click on the book cover to purchase it directly from Amazon.com).
Now let's look at some key points for selecting a good stock.
Two investment styles
When looking for solid stocks, investors tend to use one of two basic styles - value investing or growth investing.
Value investors look for stocks that are priced at less than what they are actually worth, whether it's because they are out of favor, had a bad quarter, or whatever. The value investor will search for companies that have assets valued higher than the total value of the company's stock, look at fundamentals that suggest the company's stock price is temporarily under-valued, or buy companies whose stock price has been driven down by outside factors.
This style requires absolute logic and a willingness to go against the crowd. It also requires a fair amount of research and basic accounting skills. In general prices have already fallen, so value investors minimize their downside risk.
(Fortunately there are now computer programs that can do much of the tedious research for you. See our Value Stock Selector software that pops out a list of solid, undervalued stocks with just one mouse click.)
If you can't stand the thought of paying a high premium for a company's future growth potential, this is probably the route for you.
Growth investors, on the other hand, look for companies where earnings are growing, markets are expanding, and the stock has momentum. They like companies that have a faster growth rate than the market as a whole, a leading position in a fast growing sector, or a new technology that will provide a distinct advantage.
This style of investing usually carries a higher level of downside risk, because growth stocks tend to get all the media attention, be in "hot" sectors, and draw the speculators to them. They also tend to be more volatile, than value stocks, and are thus better suited for use with Automatic Investor.
However either style will work with Automatic Investor. The key point to remember is that there are good value stocks and bad value stocks. Similarly there are good growth stocks and bad growth stocks. Choose the good ones.
Once you've found some good stocks, what do you look for next?
