Investing 101: Updated and Expanded

Chapter 5. PICKING INDIVIDUAL STOCKS

Billionaire investor Warren Buffett looks for value when he buys stocks. Peter Lynch, the investment guru who once headed Fidelity Investments' giant Magellan stock fund, seeks companies with strong growth prospects. Both have been wildly successful, showing that stock-picking success can be achieved from different angles. Indeed, there is no one right way to pick stocks.

Knowing the basics of stock picking is a fundamental skill that all serious investors need to have. One relatively basic method, variations of which are used by many professionals, is to combine the growth and value strategies prescribed by Buffett and Lynch. Look for steadily growing companies that are selling at reasonable prices.

FUNDAMENTAL INDICATORS OF VALUE

Exciting and volatile markets warrant a dull approach to investing— an approach that involves asking a lot of questions about the company's fundamental business, and then doing a little mathematical analysis. So how do you do it?

Although there are no hard-and-fast rules, many professional investors screen companies based on a number of factors, including growth in sales and earnings, cash flow, and net profits. They also look at how profits compare with total assets—a ratio better known as return on assets.

These figures are important because the future value of a company's shares is likely to hinge on its ability to grow and prosper. Growth in sales and earnings is a mathematical reading of demand for a company's products ...