Laguna Niguel, CA
Friday, February 11, 2011
Source: Expertclick.com
Potential investors in equities must choose between committing their funds to a fund, either a mutual fund or exchange traded fund, or individual stock(s). For most new investors the answer is relatively simple. They should choose a low cost fund because funds provide diversification and professional management. Furthermore, most investors would be best served by investing in a fund that is indexed to the S&P 500. From 1950 to 2009, an investment in the S&P 500 index would have produced an annual return of 11.0 percent in nominal terms and 7.0 percent after taking into account the impact of inflation. These returns occurred despite the S&P 500 having lost an average of 1.0 percent per year during the2000's (-3.4 percent in real terms).So why should an individual invest in individual stocks? The answer is that the investor believes that he/she can achieve a rate of return that exceeds that of the benchmark such as the S&P 500 against which he/she compares his/her returns. Since not all stocks in any benchmark achieve the same returns, selecting those with superior performance should allow an investor to outperform the benchmark. In order to accomplish this, an investor must understand the macroeconomic, geopolitical, and competitive environment of the industry in which a company operates. Companies that operate in industries that face challenges such as dependence on governmental largess are ones that should be scrutinized more than ones whose industry is able to prosper on its own. Companies that operate in prosperous industries and are well positioned within their industry are ones that merit further evaluation. The next consideration is an examination of the company's fundamentals to assess its historical and projected profitability and the adequacy of its financial position. The final step is to determine the company's valuation based on the metrics such as price earnings ratio, price sales ratio, return on equity, return on capital, debt equity ratio, etc.
Investing in individual stocks requires work even in cases where one receives advice from a professional money manager or broker. Having assistance in selecting individual stocks can be helpful. However, it is the investor who ultimately profits or loses not the advisor. Fortunately there is a methodology that can assist the average investor in this analysis. It is stratamentical analysis, a methodology introduced in "A Common Sense Approach to Successful Investing." It answers three very basic questions:1. Is the company strategically positioned to succeed given the macroeconomic, geopolitical, and competitive environment in which it operates? If the answer is not affirmative, then any investment would be ill advised.
2. Has the company demonstrated an ability to execute its strategy? If the company has not been able to operate profitably, one must understand what has changed that would allow it to succeed.
3. What price is appropriate for a potential investment? The strategy may be right, the company may have demonstrated an ability to execute its strategy, but the price may not justify an investment.
About the Author
Experienced as a registered representative, an individual investor and a management consultant to Fortune 500 companies, Doniger has developed his perspectives on the economy from a lifetime of smart investments. His books include A Common Sense Road Map to Uncommon Wealth, A Common Sense Approach to Successful Investing and Common Sense Prescriptions for Financial Health. He is also a regular guest on the Business Talk Radio Network and other radio shows. His articles have been published in media outlets such as Investor's Digest of Canada and Morningstar
Marvin H. Doniger
Doniger Associates
Laguna Niguel, CA
949-661-5456
