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Stock Picks Using Guesswork

Posted On: 2006-07-10
Length: 10:36

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Welcome to this Fidelity Personal Finance podcast. Today we'll try to end the guesswork in picking stocks.

It takes more than a gut feeling to pick a stock that's right for you. To improve your chances of making a successful investment, here are four questions to ask before buying a stock.

How do I identify a good stock? How does the stock fit into my portfolio? How much risk can I tolerate? Do I buy, sell, or hold? We'll take up each of these questions in the next few minutes, but first, finding the right stocks for your portfolio among the universe of more than 11,000 available to U.S. investors requires thorough research, shrewd analysis, and knowing our tolerance for financial risk. But the payoff can be well worth the effort. A well chosen stock portfolio can help to diversify your overall financial holdings and temper the risk associated with other types of assets you may own. Stocks also have a strong long-term performance record. Stocks have gained an average of 10% annually from reinvested dividends and price appreciation over the past 76 years. This is according to historical returns for the Standard and Poor's 500 index, as described in the 2005 Stocks, Bonds and Bills and Inflation Classic Edition Yearbook, by Ibbotson and Associates. And don't assume that an average return of 10% is guaranteed. According to Don Schreiber, Jr. a certified financial planner in Little Silver, New Jersey, sometimes markets make investing look easy, but investing is never easy. Don's the author of All About Dividends and Investing, from McGraw-Hill, published in 2004. Still, you can improve your chances of making a healthy profit with a systematic approach for getting in, getting out, and monitoring our investment. Understanding the risks and trade-offs in an investment in advance will remove much of the emotion and guesswork from a stock trade.

Let's consider those four questions that could help with your decision making process. First, how do I identify a good stock? A share of stock represents a claim on a portion of a company's profits. As those profits grow, your claim becomes more valuable. Success then, comes from finding companies whose profits are growing, or are about to grow. A top-down approach to finding these companies uses broad trends to identify industries and businesses that stand to benefit. For example, a declining dollar can aid exporting industries by making U.S. made goods cheaper to buy overseas. Bottom-up investors will focus on finding firms that are outperforming their competitors, or are poised to do so. You may discover one by noting an overflowing parking lot at a store, or reading a newspaper story about a promising new product. Whether you use either approach, or a combination, develop criteria and considerations you'll apply to determine what makes a stock a good buy. That will help you narrow the field to a manageable number of companies. Once that's done, the research starts in earnest. As a smart stock shopper, you want to get what you paid for, and pay the right price. Before buying, take a close look at the company. Have profits been consistent? Does management have a solid strategy for growth...

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