Choose stocks as you would election candidates
Question: How do I choose stocks to include in my portfolio?—Middle East OFW via email
Answer: On the assumption that you have already figured out what you need to earn, what your risk profile is and whether you can invest directly, here is a non-comprehensive guide for your direct investing in stocks, which was derived from the process of choosing election candidates.
1. See what they can do for you—This is not being selfish. Voting for a politician is like interviewing a candidate for a position in a company. And one of the things that companies look for in a potential employee is if he has the skills set needed by the company. The same goes with investing.
Since you already know what you need to earn and your capacity for taking on risk, try to determine if the stocks you are looking at can potentially match your return-risk profile. Take emotions of greed and fear out of the picture when choosing. It would be great to create screens like the level of prospective earnings growth and cash dividend payouts you want and need.
2. Include fiscalizers in your portfolio—You certainly want to include politicians in the mix who vote according to their conscience and not just vote with the crowd. In investing, this is similar to diversification.
While stock prices tend to move together, some move faster or slower than others. Diversification involves mixing the high flyers with the more stable ones to reduce the overall risk to your investments. But how do you measure this risk?
One way is to measure a stock’s beta. In a nutshell, beta measures how responsive a stock’s price is versus a broad market index such as the PSEi. A stock with a beta of 1 means that if the PSEi produces a 1.5 percent return, the stock will tend to produce the same performance. A stock with a beta of 2 means that if the PSEi produces a 1.5 percent return, the stock will tend to produce a 3 percent return. The higher the beta, the higher the stock’s risk level.
It takes a training program to discuss the process of deriving beta. The good news is that many research companies and stock brokers readily provide this for free.
3. Check their background—There are many third party sources available for free on the Internet that you can use to check the background of listed companies. Some of them even provide historical price charts where you can check trends, patterns, price performance, earnings and dividend history, management composition, transparency of management, labor relations, and even the level of corporate social responsibility. Last and certainly not the least, you can visit the website of the Philippine Stock Exchange itself at www.pse.com.ph.
Outside the Internet, you can go read the companies’ annual reports and review their disclosures to the SEC through the SEC iView. Focus on consistency and not just bursts of outperformance or underperformance.
4. Determine how realistic their promises are. The more jaded ones will say that promises are meant to be broken. Yet some, perhaps even many, do keep their promises. Your job is to find out if those promises are attainable.
Here is where you have to pull out your analytic skills to see if what is provided in financial projections as well as forecasts by the companies themselves is achievable. Sure, some analysts will come out with a buy, sell or hold recommendation. Ultimately though, the decision is yours to make. Therefore, it would be better to do your own analysis.
5. Forget about winnability—I have heard of people voting the leading candidates only because they do not want to waste their votes. This is herd mentality, something that can be dangerous when it comes to stock investing.
Invest like Warren Buffet, the world’s richest investor, by buying only those companies that have value but are currently selling for less. That is why step number 4 is very important. Also, buy only those companies that you know. You would not vote for a candidate you do not know, right?
If you want to learn more about investing, please visit www.personalfinance.ph. You may also want to attendEnRich on May 25, 2013 (moved from May 18), our public training on personal finance. Details for EnRich can be found on the website.
So invest as you would vote and vote as you would invest.
(Efren Ll. Cruz is a registered financial planner of RFP Philippines.)