History has proven over centuries that a company’s stock price reflects the profits the company earns. With this in mind, it’s important for every successful investor to have a set of rules in place to guide him to the best stocks and away from the worst.
Here are six profitable stock tips to keep in mind while looking at the profits a company makes:
- Consider avoiding unprofitable companies.
Many times it’s not what to buy that makes an investor successful, it’s what not to buy. The dot-com’s that burned people in the bear market of 2000-2002 were mainly unprofitable businesses, so these companies ran out of money and folded. On the other hand, eBay (EBAY) was a stellar Internet winner during 1999-2004 because eBay makes money, a lot of it. EBAY stock even made up its market losses from that 2000-2002 market to hit an all-time high in June 2004. - Don’t fall for the sucker bet.
Don’t buy stocks because somebody else gave you a hot-tip or because you thought you could make a quick trade and knock down a small profit. Every time you try to make an easy buck, it takes money away from another solid opportunity you let pass by. Think of all the great stocks we have missed out on during the past ten-years isn’t there a stock you could have sold to free up funds? Even $1000?
My personal miss-list is quite long, including Yahoo (YHOO) and America Online (AOL) in the ‘90s as well as 2003’s big winner Taser International (TASR). More recently, I didn’t buy Netflix (NFLX) and watched the stock go up ten-fold. - Evaluate each headline on how it will affect profits.
There is an incredible amount of news available on each stock, more than you and I need to worry about. When evaluating whether media hype is relevant, ask yourself if the turn of events affects the company’s profits in a meaningful way. If a company comes out with a new product, try to evaluate whether this new source of income will make a dent in the company’s profits. in 2004 Apple’s (AAPL) iPod was considered new. If profits are there, the stock may be a buy, if not, it may be more than positive PR pushing up the stock. - Look to sell stocks that don’t hit expectations.
One of the main reasons stocks get hammered is that the company announces profits will not hit analyst expectations. Sometimes, missing numbers for one quarter leads to subsequent misses in future quarters, as was the case with Lucent Technologies (LU) in 2000-2001, and caused the stock to dive more than 90 percent. - Don’t fall into the “It’ll be back” syndrome.
If your stock is down due to profits slowing — or disappearing altogether — don’t fall into the trap of convincing yourself “It’ll be back.” It may be prudent to sell the stock, then re-purchase shares after you are convinced the company has been able to get back on track. Smart investors avoid stocks when profits are uncertain wait for the company to solve its internal problems before investing. There is no guarantee profits will ever regain their old form. - Beware of companies that have profits up one year, but down the next.
Inconsistent profits lead to an inconsistent stock. When profits go up, the stock goes up. Profits go down, stock goes down. There are far too many investment choices to waste your time with a fundamentally flawed stock. In writing the book The School of Hard Stocks I looked back at WalMart (WMT) and Sears to see what each stock had done during the 1980s, 1990s and 2000s. WMT had profits up each year since 1975 while it was canvassed the country with new stores. Meanwhile Sears earned about as much per share in 2003 as it did way back in 1987 — Sears had virtually 15 years of no profit growth and so during this same time period the stock made no headway. WMT’s profits? Up more than twenty-five-fold during 1985-2004, which pushed the stock up more than twenty-five-fold as well.
Want to own the best stocks? Look for superior profits. It’s all about the profits.
