The world of investing can be complicated. There are mutual funds, exchange-traded funds, target-date funds, a variety of bonds and fixed-income products – and then, of course, individual stocks.
These days more and more investors are turning to low-cost ETFs. It begs the question: is it worth taking the time to build an individual stock portfolio? If you are willing to put in some time and research, there are advantages to individual stock ownership.
“I believe an individual investor absolutely has an advantage over professional investors if he or she is willing to do the homework necessary to understand the company, management, and the industry underlying each individual stock,” says Henry To, partner at Newport Beach, California-based CB Capital Partners.
How can an investor get started choosing stocks?
Carve out some study time. The answer is going to require some time, research and homework. There is plenty of free educational information available to wannabe investors.
The amount of resources and books on the subject of stock investing has grown exponentially over the last decade, To says. “(There are) tougher regulations on information and financial disclosures by company management. This means there now exists a much more level playing field between individual and professional investors when it comes to access to materials information.”
Develop a plan and take a long-term view. Consider this example of Starbucks Corp. (ticker SBUX). “The stock has gained 73-fold over the last 20 years. But, the stock was down by 30 percent or more from its two-year high 15 percent of the time. Your holdings will fluctuate, and you must develop an investment process that allows you to keep your conviction during times of volatility and bear markets,” To says.
Use three parameters when choosing stocks. An equity must have a strong management team with a proven track record of sticking to their strategies, timelines and execution, To says. Secondly, it should have a line of products or services that appeals to its core customer base, with a potential market size to allow long-term growth. And third, the company must be making a unique product or providing a unique service that would allow profit margins to remain high, he says.
Diversify with 10 to 30 individual stocks. There are 10 stock sectors classified by S&P Dow Jones indices. These include: energy, materials, industrials, consumer discretionary, consumer staples, health care, financials, information technology, telecommunication services and utilities.
“As a general rule you would like to own two to three of the top companies in each major sector,” says Kelley Wright, managing editor at Carlsbad, California-based Investment Quality Trends newsletter.
Rankings such as those found at U.S. News & World Report can be a guide to finding stocks. The rankings categorize stocks by returns, market capitalization, dividend yield, price-earnings and top performers, among other categories.
Be choosy. Use your research and common sense to weed out the industries that you do not like in the long run or that have historically lost money due to the lack of differentiation and competitive pressures, To says. “The mining industry is a perfect example of how an industry has lost money since its inception; airlines is another good example. Do not expect to make decent long-term returns in these industries even if you are able to pick the best or the lowest-cost operator.”
Establish an investment time frame. “If you are going to own individual stocks you need at least three to five years, the longer the better to lessen the inevitable volatility,” Wright says.
Know yourself. “To be successful in individual stock investing, you must do your homework, but more importantly, you need to have a calm temperament and trust and be confident in your own convictions and analyses. Do not let others spook you,” To says.
Assembling your portfolio may be just the beginning. But, for the interested and dedicated investor the payoffs could be worth the work.
Picking stocks requires research, time and the ability to evaluate many parameters for the stock, industry and overall economy, says DJ Verhaalen, senior financial advisor at U.S. Bancorp Investments in Milwaukee.
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“Investors today have many tools at their fingertips to make sound decisions; stock screeners, publications and brokerage firm research to name a few,” Verhaalen says. “Building a portfolio is just the start. Ongoing research and review is required to make sure the stocks are still appropriate and aligned with your goals.”