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I’m Ready to Invest – How Do I Know What Stocks to Buy?

So, I’ve finally been able to sell you on the concept of how compound interest can literally change lives and now you’re wondering how to take advantage.  Knowing what stocks to buy is obviously the hardest question to answer but it’s something that I am prepared to help you with!  But first, there are a couple things that you need to answer first:

1 – Are you wanting to invest in individual stocks or ETFs?

I know that most of us are individual stock pickers, and I am too, but I think that both have major pros and cons to them.  For example, ETFs are less risky in nature than stocks, meaning that you have less opportunity for downside but also less opportunity for upside.  That can be a pro or a con, all depending on how you look at it, and your own personal risk appetite.

Personally, I benchmark my performance to the S&P 500 because I think that “the market is the market” and that’s beyond my control, so I just try to beat the S&P 500.  If the market goes up 10%, I want 12%.  If the market is down 4%, then I hope that I am down only 2%.  

I have found that having an attitude like this keeps me a rational investor but it also tells me that it’s ok to put your money in an ETF.

I know that not everyone will agree with this, but I have no issues putting my money into an ETF.  Personally, I am super busy.  I work 60+ hour weeks, write for einvestingforbeginners.com with Andrew and Dave, am getting my MBA and have a 6-month old son, so sometimes I don’t have the full time to dedicate to finding a new company to put my money into…and it’s perfectly fine!

Now, I try to make time, but that might only come every few months.  I am adding money to my investing accounts every 2 weeks when I’m paid so I don’t like to let it just sit there, so I might set it in an ETF until then. 

Or, sometimes I will add an ETF to get more exposure to something that I’m intrigued by but don’t have a ton of knowledge in like GLD for some gold exposure as a hedge or WCLD for cloud computing stocks.  Or, maybe it’s even an ETF that has a specific investing style like MTUM with momentum investing, or a high dividend paying ETF like VYM.

In a perfect world, I am a stock picker 100% of the time, but life happens so I just do the best that I can!  But I know my risk appetite, and I know that when the going gets tough that I am going to keep my money invested, and that’s something that you need to know about yourself.

So, I would describe my investing strategy as this:

I pick individual companies that I have thoroughly researched in and have the trust that they will grow far more than they’re currently being valued.  I will invest in ETFs to gain exposure to areas of the market that I don’t know enough about and will work to better understand those sectors/strategies in the coming months.

Can you describe your investing strategy?  Honestly, that’s the first time that I ever wrote it down like that and I think it really hit home for me!

2 – What is your investing style?

Are you a value investor?  Momentum?  Growth?  Dividends? Day Trader?  Please don’t be a day trader…

This is very important to know!  Personally, I am really a mix of a lot of styles, but I know that about myself.  I would say that I am primarily a value investor because I do really look for stocks that are undervalued vs. their current intrinsic value, meaning that I think they’re worth more than they’re currently being priced at. 

This style made the most sense to me as an early investor and honestly, it still does, but I am starting to understand some of the other styles as well.

I also am a bit of a Momentum Investor as well after reading Dual Momentum Investing, a top selling book by Gary Antonacci.  That book really sold me on how badly Momentum Investing has beaten simply investing in an S&P 500 ETF for the last 40 years and it made me want to bring on a part of that into my own investing journey.

And then, I have a bit of “fun money” that’s used on some growth stocks/speculative investing.  I do this for a couple reasons:

I am a huge risk taker and really get the itch to put my money in super risky investments.  While doing this for all my investments makes me nervous, I have found that doing it on a 10% cap of my investments allows me to scratch that itch and also get some exposure to some high risk/high reward companies.

I have found that even when I do engage in this speculative investing, I still find myself somewhat taking a value look at it.  Let me explain what I mean:

A value investor looks at a stock today and says, “I think that stock is worth more than it’s being traded at, so let’s buy it”.  When I’m partaking in speculative investing, I take a stock and say, “I think that stock is trading much lower than what it will be worth in the coming years, so let’s buy it.” 

I’m not completely ignoring today’s share price, sales, profits, etc., but just more focused on the growth and the future outlook.  One company that I have mentioned before that I have been big on since early 2019 has been ROKU.  I know that they’re really, really overvalued… currently.  But I think that the growth is going to keep fueling the fire and the share price will continue to escalate.

This might seem risky, and it is in a way because I’m really focused on revenue growth, ROIC, and a lot of qualitative data, but that’s my strategy for this very small subset of my portfolio.

You need to know your investing style so that you don’t get wrapped up into other styles and start to invest in a way that’s not actually how you feel!  That’s a recipe for disaster…

So now that you have determined if you want to invest in stocks or ETFs and you have described your investing style, it’s time to determine what stocks to buy!

I really think that you can break this down into two concrete steps:

1 – Company Discovery

Honestly, this is the hardest part of trying to find a good stock to buy.  When I first started investing, I became a slave to the numbers!  I thought that there was this magic formula that I could simply use to find all these good companies.

I would go to a stock screener and put a low P/B, low P/S, low P/E, and make sure they had a lot of cash, and then boom – companies that I have never heard of and seemed to be all within the same few industries! It was demotivating to me, but that’s not to say that stock screeners can’t be useful because I absolutely think that they can.

I know that Dave and Andrew use finviz, and I do as well, for our stock screening purposes and I think it’s a great place to start if you have a general idea of some of the quantitative data that you want to look at, such as the various valuation ratios or the short-term liquidity of the business.

A different way to find companies other than stock screeners is to simply partake in active research.  “Andy, I don’t want to do any research, so please just skip this”.

No.  lol.

What I mean by “active research” is to do something that you really like to just hear about new companies.  For me, this includes three things – listening to podcasts, watching CNBC, and talking to friends/coworkers about the market. 

I love listening to podcasts and will always try to listen to the Motley Fool because I think they do an amazing job of giving so many different perspectives on various companies and industries.  They have quite a few podcasts that I love and will listen to on a regular basis.  I always have trouble learning about new industries so I love their Industry Focus podcast because it broadens my circle of competence one show at a time.

I also really enjoy watching CNBC – not for the options/trading aspect, but simply to hear the panel’s overarching thoughts and get their opinions on all different types of companies.  They really do seem knowledgeable but have a different strategy with options and market timing than I do, so I just like to listen on a purely “active research” basis. 

I will frequently hear companies that they talk about and then just go take a quick look at those companies to see their financials, qualitative data, etc.  It’s a great idea generator!

And then lastly, I have found that the more that I engage with friends and coworkers about the market, the more legit advice I will get back.  People love to talk about the market and they love to find that next great investment, so just by talking with others that are likeminded, you might get some great ideas.

I really relate it to music as a kid – everyone loved to be the first to discover a new song, but nobody would randomly walk up to someone and go, “Hey Andy, did you hear that new 50 cent song?” No!  They would only do that if they knew that I liked rap music and they’d only know that because I told them.

Investing is the same – talk about it!  You’re going to get a lot (and I mean a lot) of bad ideas (like Tesla) but worst case is you’re sparking conversation and potentially coming out with some new ideas of companies to invest in!

2 – Analysis

Now that you have found a few companies that spark your interest, it’s time for the fun to begin!  You can actually start to look at that company and see what you think about them.

There are many ways to go about this, but first I want to tell you about my process:

  • The very first thing that I do is I go to Yahoo Finance and look at the company.  This takes just a few minutes but I immediately will do a quick scan of some of those valuation ratios (insert link), the dividend, the price performance, etc. over the last few years.  I am not making any major decisions at this point but simply just scanning.
  • I then will get even a little bit more into the numbers with Seeking Alpha and/or QuickFS.net
  • Below shows a screenshot of the ROIC for a company on QuickFS.net as something that I really like to look at for my speculative investments

The next thing that I do is go to SEC.gov for the 10K.  I will do two different things here:

1 – I will input the financial data into the Value Trap Indicator.  Personally, I think that the VTI is the best tool on the market to see if a company is overvalued and it takes less than 5 minutes to populate. 

I am a huge fan of being forced to physically track your own purchases in Excel for your own personal budget.  I think that’s the best way to learn so that’s how I created Doctor Budget and investing is no different. 

I know that Andrew feels the exact same way and that’s why the VTI does all of the heavy lifting for you but you input the simple information like the sales, profits, share price, etc. when using the VTI.  And at the end of the day you’re given a value that’s either a “Strong Buy”, “Monitor”, or “Strong Sell”.  Doesn’t get any simpler than that!

2 – I will actually read through the 10K with the goal of answering these questions that Dave has outlined as a part of his stock buying checklist including some questions such as:

  • Is the business understandable?
  • Can you describe what the business does, in your own words?
  • How does the company make money?

These are simply the first three things that Dave outlines but all things that you should be prepared to answer with ease!  If you can’t then you shouldn’t invest. 

I really do encourage you to check out his post because it’s fantastic. I have even printed it out and put it on the wall in my office to help make sure that I stick to my roots when I am looking at companies because it is easy to skip over some concerning data if you want to invest in the company…that’s called confirmation bias, my friends!

If I like everything that I see, then I will start to dabble a bit in the company.  Maybe I will dollar cost average my way into this position but I will keep the remainder of my money invested in something else, potentially like an ETF (because lump sum investing has been proven to beat dollar cost averaging).

I think that buying a small amount will cause you to try to learn even more about the company and really make things start to stick for you.  You can do all the research in the world but I am a firm believer that it doesn’t matter until your own money is at work.  That’s when things really start to click.

I am much more of the believer that you should do 90% of the analysis and then make a decision.  That last 10% of analysis will take days, weeks or months to complete, and by that point the benefit is likely much less than if you had just saved the time and bought some days, weeks or months previously!

So, that’s really my strategy and checklist to invest!  It has worked for me and hopefully it will work for you as well.  If you’re getting through this and not too overly fond, or maybe you are but want to keep doing research (great idea!), then checkout Andrew’s blog on Stock Price Analysis – I think it’s a great methodology to implement into any investing process that you have, regardless if you’re looking to fine-tune your current process or start from scratch!