How to Pick and Analyze Shares

Common sense rules that can improve anyone's share analysis skills

Visit the business section of any decent library. You'll find shelves full of books on how to pick shares and share analysis. I've read most of them over the last thirty years and some are pretty good. Most are not. It isn't easy, but sorting the good stuff from the not-so-good stuff is absolutely necessary. Anyone who has read John Rothchild's book "A Fool and His Money," knows what I mean.

The biggest obstacle to finding a winning share picking system is that no system works all the time. Even the great Peter Lynch picked bummers once in a while. Nevertheless, there are some simple, common sense rules that can improve anyone's share picking skills regardless of the system they use. Here they are:

Rule 1, Favor Undervalued Stocks

Favour Undervalued Shares. The first step in picking shares is to favour shares of companies that are making money, lots of money. Study shares of companies with rapidly growing earnings and choose shares of companies which consistently make more money than they did the year before.

The question of price arises even if you do the above. Profitable, high growth shares usually sell at very high prices. How high of a price is too high? The only way to answer this question is to know what a share is really worth.

I answer this question by calculating a share's value from its earnings growth rate, profitability and other fundamentals. My formulas for calculating value are described in Chapter 3 of my book, "Stocks, Strategies & Common Sense.” Click here to get it FREE. If a share's Value is more than its Price, the share is undervalued. It's a candidate for selection.

Undervalued shares offer a higher probability of achieving gains, the potential for very large gains and lower downside risk. In other words, undervalued shares increase the odds of winning, increase the rewards for winning and decrease the risk of losing compared to overvalued shares. So, favour undervalued shares when doing your share analysis.

Rule 2, Favor Safe Stocks

Favour Safe Shares. Have you ever noticed that the prices of shares like Coca Cola and McDonalds never seem to cause any excitement, yet go up year after year? Shares like Chrysler are always in the news, and go up and down like a yo-yo. There's a very simple reason for this contrast. The former have track records of steady earnings performance while the latter has an erratic earnings record. Price volatility is a reflection of fear and uncertainty.

Price volatility and risk arise from many sources...rumors, political assassinations, earthquakes and so on. Shareholders with little confidence in their company tend to overreact to rumors and bad news. Consequently, the share prices of companies with erratic earnings performance suffer more when unfortunate things happen. Shares of companies with steady, predictable earnings can weather nearly any storm.

Obviously, there's less risk in holding shares of financially stable companies. Consequently, I analyse the risk factors of shares very carefully before buying.

The second key factor in picking shares is to favour safe shares.

Rule 3, Favor Stocks with Rising Prices

Favour Shares with Rising Prices. The hardest thing for most investors to do is buy a share while its price is rising. Most of us have been taught to wait for a share to go down before buying it. The idea of buying share at a lower price makes a lot of sense, but is fallacious.

First of all, you'll miss a lot of good opportunities. Really good shares usually don't look back once they have started moving upward. Witness the hundreds of shares that have doubled and tripled over the last few years with nary a downturn.

Even more importantly, you never know where the bottom is when buying a share whose price is falling. Remember when Amazon went from 106.69 to 5.97? Who'd of believed it? I did because VectorVest did not reflect Amazon as being undervalued or safe as it was going down. However, when things started turning around and Amazon's price started rising again, we gave it a buy signal.

Buying shares on the way down lessens your chances of winning. Most of us dream of buying a share at its low point and riding it to the moon. It's a great dream, but the chances of doing so are virtually nil. The low points on good shares don't last long. You have to be very lucky to bag a bottom.

Picking shares with rising prices not only obviates the above problems, but offers several advantages. First, a share that is rising in price is already doing what you want it to do. (You don't have to break a rising share of a bad habit.)

Buying shares with rising prices does not preclude the idea of buying them right after they hit bottom. Bottom Fishing is a great sport. You just have to know when the price trend has gone from down to up.

Finally, a share that is hitting new highs has essentially no overhead resistance. There are no unhappy buyers waiting to get their money back. I especially like to buy shares hitting their very first 52-WEEK high. These shares have had plenty of time to consolidate, and are showing new signs of life.

It's fun to own shares with rising prices. So pick shares with rising prices.

Rule of Rules:

Pick Safe, Undervalued Shares with Rising Prices. That's easy to say, but how does one find safe, undervalued shares rising in price? Try following these steps:

1. Look at the financial section of your local paper, the Wall Street Journal, Investor's Business Daily, Barrons, the internet or whatever. Find the list of shares that have just hit new 52-WEEK highs. All of these shares are definitely rising in price.

2. Rank all these shares in ascending order of Price to Earnings ratio, i.e., P/E ratio. This may take some work, but low P/E ratio shares of course, are undervalued.

3. Assess each share for safety. Since the subject of safety is not touched upon in the papers, you'll have to turn to other sources. Take a look at Value Line, for example or Standard & Poor's Share Guide.

4. Now put all the information together in a logical, quantitative, unemotional way. Pick the ones you think are the safest, most undervalued and rising in price the fastest.

Once you have prepared your list of shares, check them out using VectorVest. VectorVest's share analysis and graphics software analyses over 18,300 shares every day for Value, Safety and Timing. It unifies these factors into a comprehensive indicator called VST-Vector. Shares with the highest VST-Vector ratings have the best combinations of Value, Safety and Timing.

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There's no need to spend hours and hours doing what VectorVest has already done. You can obtain a complete, rank analysis of any list of shares with VectorVest in just a few seconds. Our records show that shares with the highest VST-Vector ratings outperform the market over the long-term.

This comes as no surprise. Common sense and simple logic dictate that picking safe, undervalued shares rising in price should result in above average performance.