Your Next Great Stock: How to Screen the Market for Tomorrow's Top Performers

Chapter 2. You Can Beat the Stock Market

Stock picking is becoming rarer everywhere in the world. Indexing, the opposite of stock picking, is becoming more popular. Stock picking is the act of choosing stocks that look likely to produce better returns than the overall stock market. Indexing refers to buying large baskets of stocks designed to track, but not beat, the market.

It might seem as though stock picking is as popular as ever. Wall Street firms issue regular recommendations on which stocks you should "buy," "sell" and "hold." Pundits argue over whether Google is headed higher or Intel is due for a comeback. Jim Cramer of CNBC's Mad Money bites the heads off of toy bulls and throws chairs around the set while delivering dozens of stock picks each night. But those are anecdotal examples. The flow of investor money tells a different story.

The most popular stock index by far is the S&P 500. Loosely speaking, it tracks the performance of America's 500 largest companies ranked by market value. A company's market value is the amount it would cost you to buy the entire company by purchasing all of its shares. The S&P 500 itself isn't an investment. Investors track its movements to get an idea of what the overall stock market is doing. Many index mutual funds are set up to mimic the S&P 500. At the end of 2005, these S&P 500 funds held $1.26 trillion in assets, according to Standard & Poor's, which owns the index (and charges licensing fees to mutual funds that mimic it). That's just ...