The Smart Guide to Stupid Investments
How to get a rise out of the stock market
By Stephen M. Polland and Mark Levine
The recent stock market swan dive has turned a lot of guys from shrewd to screwed. Call us square, but unless you are one sophisticated cat, we don't believe you should try stock picking. Yeah, mutual-fund holders got whacked, too, but God invented mutual funds for a reason: to spread out risk, hold up the bottom, and build wealth.
That said, we know some of you are going to buy individual stocks anyway. Guys drive too fast, love too hard, climb too high, and will-in spite of advice from financial professionals who love them-venture into the jungle of single stocks. Remember these rules and you may actually make some money when you ignore our advice.
SCRATCH THE ITCH, BUT DON’T DRAW BLOOD
If a swoon in the price of your chosen stock would be a disaster, you're in too deep. A couple of grand should satisfy the craving. Under no circumstances should you gamble with more than half of what you would normally spend on a new car.
DANCE WITH WHO BRUNG YA
You'll have a better chance if you stick with businesses you know something about. But not your own company or industry. You're already heavily "invested" in that. Instead, look to products and services you use, to your own interests and hobbies. Of course, Frito Lay and the Green Bay Packers don't exactly add up to a blue-chip portfolio.
THERE'S NO GREEN IN GREENPEACE
Socially conscious companies and funds perform about 4 percent below the Standard & Poor's average. That’s because they have higher costs of doing business. If you want to protect Mother Earth, make charitable donations with a portion of the profits from your oil company stocks. And ditch the spotted-owl-skin shoes.
THROW OUT YOUR WATCH
Nobody knows when a market or stock has hit bottom, so trying to time your stock purchases is folly. Rather than betting your whole bankroll on one crazy, optimistic afternoon, buy a few shares at regular intervals. This is called dollar cost averaging, and it works. Let's say you want to invest $6,000 in a new online rent-a-pet venture, iguanas2u.com. Rather than trying to figure out when the stock has hit its lowest value, simply invest $500 every month. Sometimes you'll be buying when its price is high, and sometimes when it's low, but you'll usually end up doing better overall than the crystal-ball-reading schmoes who are absolutely sure the stock hit bottom at
Same wisdom applies to selling. If you're looking to turn over a stock, sell some of it as soon as you see a moderate up-ward trend. Don't be greedy. Remember the old stock market adage: Bears make money and bulls make money, but pigs get slaughtered.
TRAVELCAREFULLY
Invest only in foreign countries where they like capitalism and the government is reasonably stable. Here's a handy decision-making question: Would you let your daughter go to college in that country?
IGNORE THE HYPE, READ THE FINE PRINT
Once you find a stock that looks interesting-did we mention you shouldn't try to pick individual stocks?-order annual report or a prospectus, then ignore most of it. Instead, just turn to the back and peruse those boring financial statements for a few key and easy-to-calculate numbers.
CONSIDER THE PE RATIO
The price-earnings ratio is probably the most famous number people look at when stock picking. It's a fraction, built of the stock‘s price divided by the annual earnings per share. If a single share costs $50 and earns $2 a year, the stock has a 25:1, PE ratio. Cross any stock with a PE ratio of more than 10:1 off your list of potential buys.
CHECK THE ASSETS
Check the balance sheet in the back of the prospectus and look for the three numbers representing current inventory, cash on hand, and accounts receivable. Add them up. That's how much the company has available to pay its bills. Next, add the accounts-payable number to the figure for short-term debts due. That's the company's total bills. If the first number equals the second, the company has a liquidity ratio of 1:1, meaning just enough money on hand to pay the bills. This is okay, but not optimal. Just as you should have a cushion at the end of the month, so should a company. The more extra money on hand, the higher the liquidity ratio, and the safer the buy. A ratio of less than 1:1 is a warning sign. Steer clear of a company that has to borrow to meet its bills or expects help from friendly suppliers.
BELIEVE IN BOOK VALUE
If you came across a 1965 T-bird in mint condition selling for only 10 grand, you'd grab it, right? Well, the same is true for investments. If a company's shares are selling for less than their book value, jump on them. There's no blue book for stocks, but it's easy to figure out their value on your own. Turn to the balance sheet. Find the total of hard assets. Then look to see the number of shares outstanding. Divide the by the number of shares assets and you've got the book value of each share.
Let's say you're thinking of investing in a stock that your brother-in-law touting: Guava Queen, a new fast-food chain selling up scale water wieners. The company's balance sheet shows total assets of $500,000, and there are 10,000 outstanding shares. That means each share has a book value of $50. If the stock is selling for $30a share and the company is earning money, buy it. Even your brother-in-law could be right once in his life.
WATCH FOR WORRY WORDS
Almost every financial statement has foot notes. Most are just technical clarifications. However, there are two serious caution-flag phrases to watch for in the fine print:
Pending litigation. If you see this, put the prospectus down and run, don't walk, to a driversified mutual fund. It could be nothing, but if it merited a mention, it worrisome enough that you should take your money elsewhere.
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