Investors can manage their risk in picking individual stocks by following some simple rules:
• Require that the company have at least five years of financial history. Younger firms haven’t developed enough of a track record for assessing management performance.
• Study only companies that have proven they can make money. Someone who invests in a company that has never reported earnings is speculating, not investing.
• Understand the possible risk and reward of owning a stock.
• Diversify your portfolio. Even if you’ve done your homework on every holding using all the information you need to make an informed decision, you’ll still make mistakes. If you have a good-size basket of stocks, however, you’ll also have some stocks that perform much better than expected.
Besides investing in high-quality growth stocks and diversifying your portfolio, two other simple principles can help you build wealth over the long term.
- First, reinvest all your dividends and earnings.
- Second, invest regularly in both good markets and bad; this is often called dollar-cost averaging.
The type of analysis outlined provides a lot of the information fundamental investors need to determine whether a stock is a suitable investment. But not everything. Reading annual reports, listening to conference calls and viewing company presentations will help you form a fuller picture of the company.
In today’s unpredictable, volatile market, fundamental analysis is even more important than usual. But for an investor using a simple, straightforward methodology that focuses on the long term, these are also times of great opportunity.