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  • Writer's pictureMMH CPA

Selecting the Right Stocks

As we have witnessed volatile activity in the stock market in recent years, the old stock selection rules are not always applicable. Seasoned investors and new investors alike want a sure-fire way to pick the winners.

While no one can offer any guarantees, smart investors do have certain characteristics they associate with a winning stock. A crucial key is that the stock should meet certain criteria. There are always good stocks that don't fit the mold, but historically, the stocks with the biggest gains shared most, if not all, of these features:

  • Strong balance sheet. Look for companies with a low debt-to-equity ratio. In recessionary times, debt-laden companies may not stay afloat.

  • Low price-to-earnings ratio. P/E ratios are usually industry-driven, so make sure you compare similar companies. Low P/E ratio may mean an increased rate of return on your investment.

  • Good management. A strong management team and a leadership position in their industry are earmarks of a good company. Look for a history of steady growth to assess staying power.

  • Book value. A stock priced lower than its book value provides extra assurance that your investment will not go sour.

  • Good dividends. A strong dividend history with regular increases adds to a stock's desirability. A healthy income stream can make the wait for growth returns more pleasant, and it helps prop up a stock's price in a falling market.

  • Undervalued assets. Company assets such as real estate and mineral holdings may be worth dramatically more than the balance sheet and stock price indicate. Companies with undervalued assets may be tempting to conglomerates in these days of merger mania.

  • Broad ownership base. A stock that is held by relatively few investors is much more likely to be subjected to dramatic drops if a major holder decides to bail out.

  • Basic industries. Shy away from faddish industries, notorious for meteoric rise and fall. When timing is the most crucial element in an investment's return, it becomes more akin to gambling than investing.

  • Strong cash flow. Healthy cash flow will help a company weather economic downturns. It might also make the company a takeover target since takeover debt can be paid off with the surplus dollars.

  • Unusually low price. A low price when compared to the stock's average historical price could indicate a bargain if the drop is due to market forces rather than changes in the company.

Though there is no magic way to select stock winners, the hallmarks of a good stock value are somewhat ascertainable. Good investing requires legwork and attention to detail, but that's a small price to pay for a healthy portfolio.

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