David Alfred shares tips on picking stocks
Portfolios with Purpose is a fantasy stock trading contest where you can win money for your favorite charity. Professional class player David Alfred from Bank of America shares six tips on how to pick a stock to create a winning portfolio.
#1 Buy What You Know
Start with a company that's familiar to you. If Lululemon raised prices on your favorite pair of workout sweats or Chipotle upped the price of its burrito bowl, but you have to have those items, that’s inelasticity of demand and it’s probably a good thing that Lulu and Chipotle can keep price. Inevitably this means it’s good for the earnings power of those companies. There's more to it than just that, but keeping abreast of trends and applying your mentality as a consumer of everyday goods can make you a leading indicator for stock investing.
#2 Consider Price and Valuation
The most common metric for valuing stocks is Price to Earnings; what is the price you are willing to pay for that earnings stream. It’s a relative value game. Here is an example: A basket of stocks like the S&P 500 was trading at 20x next year earnings and the average weighted growth of that index was 5–10% but a homebuilder like DR Horton could grow 15–20% over the next few years and is trading at 11x earnings. That's a buy signal for DR Horton; how could it trade at a sub-market multiple for something that could grow 2–3x greater? DHI may be a really undervalued stock.
#3 Identify a Catalyst
Don’t just invest on the basis of price. Find an event unlocking which will allow for share price appreciation. Look at company earnings transcripts or presentations to see if management has hinted at doing share buybacks, special dividends, asset sales or maybe even spinning out underappreciated non-core assets. It could be that the company is the perfect strategic fit for a takeover like Microsoft’s acquisition of LinkedIn.
#4 Good Management Teams are Important
You want to make sure your interests as a shareholder are aligned with a company's management team. Does management have significant skin in the game, or are they compensated in stock or out of the money options? If so, they are incentivized to create shareholder value. CEOs, CFOs and the Board of Directors' fiduciary duty is to drive share price, make sure management teams are seasoned operators and have track records of successfully growing revenues and cutting costs.
#5 Dig Into the Company's Financial Reports
Look for consistent history of profitability and financial health, not just one good quarter. And make sure to check the Investor Relations section of a company’s web site, or find official reports filed with the SEC online. Don't just focus on the most recent report. Check the company's balance sheet. If a company is generating sufficient cash to pay down or refinance debt cheaper this can serve as a catalyst for earnings windfall.
#6 Find a Dividend
A dividend, a cash payout to stock investors, is a sign that a company is in good financial health. If a company pays a dividend, look at the history of their payments. If a company isn’t steadily profitable, scratch it off your list.