Investing Knowledge Lesson #1

As part of this blog, there will be snippets of information that I come across, that is worth sharing, to give you some background information without overloading your senses on a bunch of financial information that may be confusing. In most cases, I will be paraphrasing where I can, in order to give the information in a clear, concise manner.

Keep in mind, that we are looking at gaining as much knowledge on how the market works, what to look for, and how to read the information, in preparation for moving into the world of e-trading going into 2006. When we are looking at potential stock buys, there are 6 major considerations in picking a stock;

1. KNOW THE COMPANIES
Every fund manager agrees that knowing the companies as thoroughly as possible -- a strong grasp of their financials, their products, their suppliers, their managers, and customers -- is key to controlling risk.

2. DIVERSIFY AMONG SECTORS
Individual investors can study correlations and volatility at a free Web site, riskgrades.com (details on how the riskgrades.com site works, and what to look for, will be covered in a future entry). The site assigns each stock a "risk grade" and then one for your portfolio. Ideally, the risk grade of the whole should be less than the average of the parts. One caveat: Risk is always changing, so you need to monitor it. We will be considering a variety of stock holdings in the future, in order to minimize our risk.

3. MARGIN OF SAFETY Value managers have their own form of risk control called the "margin of safety" that's straight out of financial textbooks. They'll buy a stock only at a deep discount to what they perceive is its "intrinsic value," or the price it would fetch in a private acquisition. The idea is to buy at prices so low they have little room to fall.

4. DIVIDENDS Stocks that pay dividends are generally less volatile than ones that don't. For one thing, the cash flow from the dividend cushions the portfolio in bear markets. In addition, many investors who own these stocks hold them for the long term so they can collect their payouts, thus reducing the daily volatility caused by active traders.

5. "ECONOMIC MOATS"
These companies often succeed because they have competitive advantages or "economic moats" that protect their businesses. Stryker, the dominant player in the orthopedic implant industry, is one such “moat”. True, it has patents protecting many of its products from competitors, and patents eventually expire. But what won't change, is the growing ranks of seniors, who are the main customers for Stryker's products.

6. DEFENSIVE TRADING
Many investors would not associate frequent trading with low-risk portfolios. Risk can be kept in check with lots of buying and selling. The idea is to weed out stocks that have hit price targets or have fallen.Here's how the defensive trading works. Nextel was at 15 a share in June, 2003, then hit 26 in December of that year. In June, 2004, the stock dropped 20% on worries about a competing technology. If you decided that the concerns were insignificant, you purchased the stock again at around 21. You could have sold it once more late last year for a 17% gain when news broke that Sprint would be acquiring Nextel.If a company has an ugly earnings report that is not the result of a one-time event, then it’s probably a good idea not to hold onto that stock for above average returns.

These points are critical for future analysis that we will be doing. Happy reading, and as always, feedback is welcome, and if you have a question, feel free to leave a comment.

Up Next Blog – Investing Knowledge Lesson #2