How to win any investments in Stock Market

If you are new to investing, you might have the idea that a rational person can buy stock in some promising companies, for the long term, and be happy with their investment. Nope.

When you purchase stock, the word "stress" takes on a whole new meaning. Someone who thinks nothing of blowing $100 on dinner or buying a $35,000 car, can have his whole day ruined when he reads the morning paper or listens to the radio and finds that his best stock dropped $2 a share yesterday.

The investor always reads the business section of the paper first, turning to the stock tables to see how his life is doing. Or he checks them out using his computer. This sets his mood for the day. If his stocks are up, everything is beautiful and off to work he goes with a big smile. He says proudly "I picked that stock!"

But if his stocks are down, we've got Mr. Grumpy for the rest of the day. He's telling himself:

"I shouldn't have bought that one" or "I should have sold it when it was up - taken my profit" or "why did I listen to my broker/friend/barber/that taxi driver" or "XYZ is up $4.00 today. I should have bought it. I knew it!" Then he turns on the radio and hears that the Dow is down 80 points. He shouts "darn". I have a theory that this is the chief cause of road rage.

Here are a few more real-life quotes from stock market investors:

"I shouldn't have sold that one. I knew I should have bought some more when it was cheap. Look at what it's up to now. I should have hung on to it. I knew it was going back up. I knew it!"

"It went up just because I didn't buy it" or "just because I sold it."

"If I sell it, it'll go up. If I buy it, it'll go down. It's like the market's watching me."

"I'd grab the remote, flip on CNBC and watch the ticker roll across the bottom of the TV screen, woooeee! I could watch it for hours."

Most investors become addicted to the market. It becomes an obsession. It's all they want to talk about and pursue.

And so far, we've just been describing the casual investor. Pity the poor "day trader" whose computer screen is flashing new stock prices every second. He tries to time his buying and selling to take advantage of small price moves throughout the day. A United States Senate investigation committee found that 3 out of 4 day traders lose all their money.

Since the day trader usually buys too soon and sells too late, he watches his $100,000 nest-egg dwindle to nothing as the broker takes his commission every time the trader buys or sells something. Day traders buy Maalox by the case.

I guess stock market traders fail to understand this simple principle: when you jump in and buy a stock, it will do only one of two things

The price will go up
The price will go down (it never stays exactly the same)

And you have absolutely no control over, or reasonable way to predict, which way the price will go!

Are you thinking "After reading the last page, I don't think stocks are for me. Aren't there any easy, sure-fire investments?"

Sure. Most of us are familiar with the traditional EE savings bonds, but the new iBONDS, first offered in 1998, are a whole lot better. All earnings grow tax-deferred. You never earn less than a guaranteed base rate, currently 2%. Now paying 4.4% a year, iBONDS are adjusted periodically for the rise and fall of inflation. I will repeat, if inflation goes up, your interest rate goes up too!

But you're not reading this book to learn about boring savings bonds. I really hope that you are a little more adventurous and have a bit more risk tolerance than the typical savings bond investor.

Mutual funds should be your core investments. Properly chosen, they can be safe and a sure thing. But before we explore mutual funds, we'll continue with stock market trading. But I give you fair warning, If You Already Have Enough Stress In Your Life, Your Investment Solution Is Mutual Funds, not individual stocks.

When you begin buying and selling stock, you may find yourself on the greed-fear roller coaster, greed when things are going well, and fear when the market is tumbling. Hope and despair are also part of this cycle. It causes your judgment to become clouded as your emotions take over.

How to Invest Smart

If you can't rely on your own research, or if you don’t have time to do the research, you might as well make your investment decisions based on tips from that smart guy at work. No, no, I'm just kidding. Tips are for restaurants.

Important Rules to Follow When Buying a Stock

These suggestions are presented with the assumption that you intend to remain a casual investor. I strongly recommend mastering the art of technical analysis (reading charts, analyzing price and volume moves) if you intend to become more serious about the timing of your purchases.

With this said, you should still be able to buy good stocks if you follow these rules:

Don't ever buy a stock without first examining its financial health. You are going to learn how to do this.
Don't ever buy a stock without first learning about its business and who its competition is. You want to focus on the leaders in an industry.
Buy when market indexes are in an up-trend. Don't try to bottom-guess, wait until the stock or the market has clearly turned around, with several days of price increases on larger than usual volume.
Buy the top companies of industries or market sectors with many stocks hitting new highs.
Buy companies with new products or services that are expanding (profitably), especially young companies.
Determine if large or small-cap stocks are favored in the current market.
Pick companies with high management ownership. With their personal stake, there will be a tendency to make moves that will stimulate investor's interest.
Quarterly earnings should be up at least 25% in each of the past three quarters.
Earnings should be up at least 25% in each of the last three years, or at least 40% for the past two years. If it is a young company, sales should be up over 50% for each of the past four quarters.
If sales are not increasing by at least 10% in each of the past three quarters over the same quarters in the prior year, pass on it.
Always average up with your winners – let your winners run.
Never average down – get out of the stock if it goes against you. Buying more because it’s cheaper and a “bargain” is one of the biggest temptations, and very hard to resist. But dollar-cost-averaging individual stocks that are falling in price, is a really bad strategy.

What about the famous "buy and hold" strategy championed by Warren Buffet (probably the best stock market investor ever) and Peter Lynch (maybe the best mutual fund manager ever). It's hard to argue with success, but there really are times to sell if you want to limit your losses and protect your profits.

Analyzing Financial Statements

A company’s financial statements tell you what a company has (its assets), what it owes (its liabilities), its sales (revenue), and how much it made in the accounting period being reported (its profit or net earnings).

What are some things to look for?

The Income Statement

Many believe that the number one figure to look at is the company’s sales. If sales aren’t going up, you need to find out why.

If sales are rising buy profit isn’t going up proportionately, look out. The company may be slashing prices out of desperation.

If a company’s earnings are going up faster than sales, it might be due to creative accounting. Now really look out.

The ratio of price-per-share to sales-per-share for the S&P 500 is currently about 1.7 times sales. Some experts believe that if this ratio falls below .5 for a profitable company, then the stock is a bargain, others say under 1.0 or under 1.2. Take your pick.

But growing companies with fat profit margins can consistently trade at over 10 times sales. Yahoo, in 1999, traded at 1,200 times sales, and it had never yet made a profit!

Take a look at net income to total capital from the balance sheet, called return on capital or ROC. This is a good gauge of earnings stability.

Operating cash flow is generally considered to be profits before interest, taxes, depreciation, and amortization (such as writing off leased assets) and is called EBITDA.

The Golden Piggy Bank Page 104 You want this number to be at least 20% greater than the net income figure. In 2000, the top 100 gaining stocks had a cash flow number over 60% greater than net income.

Statement of Cash Flow

Now required by the SEC, this tells investors about the increases and decreases in assets and liabilities, which have a direct effect on cash in the bank.

You can get a feel for where the income came from, and where it went. Not all earnings come from a company’s everyday sales. This statement will show activities such as investments or sales of fixed assets such as a plant. Negative cash flow is bad.

The Balance Sheet

Debt is the money that a company owes for long-term financing, either from traditional lenders or from the sale of corporate bonds.

Compare debt to total capital (equity). Too much debt is risky, since a slowdown in sales could threaten a company’s ability to pay its obligations.

Many experts say that over 50% is too much. But you must look further to see what the debt has been used for. If the money was used for earnings-producing plant and equipment – good. If it was used for corporate perks, such as the millions to WorldCom’s CEO for such things as a lavish $15 million penthouse – bad.

There are dozens of ratios, such as the “current ratio” (current assets to current liabilities) that bankers use to evaluate the financial health of a company. I am intentionally skipping these because experience has taught me that they are mostly a waste of time.

When comparing the sales of a retailer or restaurant chain, be sure to use “same-store” comparisons, ones that have been open at least a year. Dividing the company’s earnings by the number of stores will give you an idea of the profitability of each unit.

The Golden Rule of Investing

If there is a golden rule of investing, it should be the discipline to cut your losses when a stock drops 7-10%. The usual protest to this idea is "what if the stock goes right back up, as I know it's going to do? I've lost 10% of my money for no good reason."

Let's take a logical look at this argument. If a company's stock price drops 8%, it can then do three things. It can go right back up (but then why did it take a big drop in the first place? Hmmm), stay right where it is, or most likely drop even further. Sorry, but dropping to even a lower price is what’s most likely to happen.

For example, you buy a stock at $25.00, it drops to $23 where you sell and take a $2 loss. Over several weeks or months, you watch it drop down and hold at a "support level" of $17 to $19. The price begins to move up so you buy back in at $20. A month later it is back to $25.00.

If you had simply held on to the shares, you are now back to a break-even point. But by getting out early then buying back in as it began to come back, you made $5, minus the $2 loss, for a gain of $3 per share. Not only that, you protected your investment from greater loses if the stock continued falling and not regaining its old price level. This happens all the time!

I know so many investors that have stocks in their portfolios of good companies, and the stock seemed fairly priced and had great potential when they purchased it. They bought IBM at $125, then watched it drop to $65.00. They bought AT&T at $60, then watched it drop to $9.00. They bought Enron at $70.00, then watched it drop to $0.00.

And what were they saying while the stock was tanking? “This is a good, solid company. The price will go right back up. I can’t sell it now, at a loss!” Then they would say something like “I’m going to hang on to it until I just get even.” Do you want stocks in your portfolio that the best that you are hoping for, is to break even?

I know this sounds silly that a person would hold on to losers, but believe me, most people do. Don't let yourself become trapped by a stock that's costing you money. The only good stock is one that's making money for you.

It is also likely that if most of your stocks are dropping in price (assuming you have selected them based on their growth and solid earnings performance), then the whole market may be in a downturn. The Nasdaq lost 75% of its value from March 8, 2000 to July 20, 2002. The S&P 500, from January 1973 to September 1974, lost 43%.

A smart investor, rather than trying to beat a bear market, will keep his cash on the side, ready to jump in when the next bull market takes off. That is the time to shop for bargains in discounted, solid companies.

So I’ll repeat this golden rule of investing: cut your losses when a stock drops 7-10%. All big losses start out as small ones.

Investing should not be ”buy, hold, and keep your fingers crossed”. Invest the right way and you won’t have to worry about your investments. You want to sleep at night.

Important Selling Rules

Sell if your stock drops 8-10% from the price you paid. I can't repeat this often enough. If the price begins dropping on high volume, don't wait for an 8% haircut - sell it now.
Continually re-evaluate to see if the same reasons are still there for owning the stock. If it isn't one that you would buy today at today's price, sell it.
If the stock creeps up for several days on very light volume and there are other sell signals, this is a good time to sell it.

If after months of advancing, the stock suddenly jumps way up on heavy volume, maybe 25% or more in just a week or two, it will probably pull back significantly. This is called a climax top. When it makes its biggest one-day rise, sell.
When a stock suddenly jumps up on weak volume, sell.
If a stock closes at the bottom of its day's trading range on high volume, consider selling half your shares.
If a stock drops below its 50 day moving average on heavy volume, or closes down on record volume, sell.
If there are 3 days with the market dropping on heavy trading, reduce your positions. This may be signaling the start of a bear market, or a baby bear.
If the Put/Call Premium Ratio (found in the Wall Street Journal and IBD) rises to over 2.0, begin reducing your positions. A big market drop is on the way within a few months.
Don't ever sell and take a profit if your leading stock runs up 20% or more in only 2 or 3 weeks. Most market leaders last a year or more
On any bad news about a company whose stock you own, sell. Wait until the air clears and the stock begins rising again before repurchasing.
When you review your portfolio of stocks, the laggards will clearly stand out. Sell them and buy more of your winners. As many wise investors have found, it’s a good practice to weed your garden regularly.

It is hard to sell a stock at a loss when we believe that we are skillful investors. But are we really that skillful? We can and should control basic investment things like minimizing taxes, keeping trading costs down, and maintaining the quality of our investments.

But no matter how much effort we put into beating the market, we’ll probably be disappointed. We figure that if we spend enough time hunting for hot stocks and searching for the superstar mutual funds, we will spot them.

This is an illusion. We can only control our investment results in a basic way. The rest, for better or worse, is just good or bad luck.

Sometimes you can't invest in a company because they are owned by someone else, such as Entenmann's and 7up, both owned by Philip Morris (renamed Altria Group) or Taco Bell, KFC, and Pizza Hut, owned by Tricon.

The company may also be a privately owned corporation such as Levi Strauss, Domino's Pizza, Kinko's, or Hallmark Cards.

The major cycles of the stock market include:

The four-year presidential cycle in the USA.

Annual seasonality, in the USA and other countries.

"The Halloween indicator" (or "Sell in May and Go Away")

The "January effect"

The lunar cycle

The 17.6 Year Stock Market Cycle

The Halloween indicator is a variant of the stock market adage, "sell in May and go away," the belief that the period from November to April inclusive has significantly stronger growth on average than the other months. In such strategies, stocks are sold at the start of May and the proceeds held in cash (e.g. a money market fund); stocks are bought again in the autumn, typically around Halloween.

The four-year U.S. presidential cycle is attributed to politics and its impact on America's economic policies and market sentiment. Either or both of these factors could be the cause for the stock market's statistically improved performance during most of the third and fourth years of a president's four-year term.

The business cycle is the upward and downward movements of levels of GDP (gross domestic product) and refers to the period of expansions and contractions in the level of economic activities (business fluctuations) around its long-term growth trend.