1. How to Build a Stock Portfolio:
1. Portfolio-Building Strategies
2. Evaluating Stocks for your Portfolio
The stock market and its potential for risk intimidates many people.
Nonetheless, a well built stock portfolio, over time, will outperform
other investments. It is possible to build a stock portfolio yourself, but
even if you work with a broker, understanding your goals as well as the
nature of the market will help build a successful investing strategy.
Below are steps on how to build a stock portfolio and how to evaluate
stocks to build your portfolio with.
3. 1. Commit to investing over the long term.
a) It is possible to make "a killing in the market" by making a lot of
money on a stock in a short period of time, but that sudden gain can
be wiped out by an equally sudden loss. A sustained presence in
the market is more likely to pay over time than trying to make a
quick buck.
b) As part of investing over the long term, determine how much money
you won't need to touch for 5 years or longer and set that aside for
investing. Money you'll need in a shorter period of time should be
invested in shorter-term investments.
4. 2 Understand the different kinds of stocks.
Stocks represent an ownership stake, or share in the
company that issues them. The money generated from
the sale of stock is used by the company for its capital
projects, and the profits generated by the company's
operation may be returned to investors in the form of
dividends. Stocks come in 2 varieties: common and
preferred stocks. Preferred stocks are so called
because holders of these stocks are paid dividends
before owners of common stocks. Most stocks,
however, are common stocks, which can be subdivided
into the categories below:
5. a) Growth stocks are those stocks projected to increase in value
faster than the rest of the market in general, based on their prior
performance record. They entail more risk over time but offer
greater rewards in the end.
b) Income or value stocks are those that pay better dividends than
other stocks. This category can include both common and
preferred stocks.
c) Blue-chip stocks are stocks that have performed well as either
growth or income stocks for a long enough period of time that
they are considered safe investments. They may not grow as
rapidly as stocks designated as growth stocks or pay as well at a
given time as stocks designated as income stocks, but they can
be depended upon for steady growth or steady income. They are
not, however, immune from the fortunes of the market.
6. d) Defensive stocks are stocks for companies whose products and services people
buy, no matter what the economy is doing. They include the stocks of food and
beverage companies, pharmaceutical companies and utility companies.
e) Cyclical stocks, in contrast, rise and fall with the economy. They include the
stocks of such industries as airlines, chemicals, home building and steel
manufacturers.
f) Speculative stocks include the offerings of young companies with new
technologies and older companies with new executive talent. They draw
investors looking for something new or a way to beat the market. Most of these
stocks don't do well.
7. 3. Develop an investment strategy that meets your goals.
a) Decide what type of stock portfolio is most important to meet your
overall financial goals. If making a lot of money over time is
important to you, you'll want to build a stock portfolio of largely
growth stocks, with some blue-chip and income stocks and possibly
either a few well timed cyclical stocks or well researched speculative
stocks. If you need to earn a continuing income from stocks, you'll
want to build a portfolio composed primarily of income stocks, with
some blue-chip and defensive stocks for balance.
b) Understand that your financial goals may change over time and adjust your
portfolio over time. Generally, the younger you are, the more risk you can
take and may be better served with a growth-oriented portfolio, while the
older you become, the more you'll need a source of income and may be
better served with an income-oriented portfolio.
8. 4. Diversify your holdings.
a) Regardless of whether you pursue a growth-oriented or incomeoriented strategy, you should rely on more than 1 or 2 stocks to
make up your portfolio. Investing in multiple stocks spreads your risk
over several companies and possibly several industries and classes
of stock, depending on how you build your portfolio. Ideally, poor
performance by 1 or 2 stocks will be offset by significant gains in the
other stocks.
b) One way to ensure diverse holdings is to invest in stock mutual funds, either
in combination with or in place of direct stock ownership. Mutual funds are
often good for new investors to the stock market, giving them a chance to
learn the ins and outs of the market as they reap the benefits of investing.
9. 5. Invest regularly.
a) Just as saving regularly can build your bank balance, investing
regularly can build your portfolio over time. Buying stock or mutual
fund shares on a regular basis lets you take advantage of dollar cost
averaging, which lets you buy more shares per dollar during times
when stock prices are low and take advantage of the increased
value when prices are high.
b) One type of portfolio in which you can invest regularly without a
broker's assistance is a direct investing, or DRIP, portfolio. DRIP
portfolios usually require a smaller initial investment than most
brokerage offerings because there are no broker fees, and they let
you start with a smaller number of stocks that you can research
before buying and track afterward.
10. Method 2 of 2: Evaluating Stocks for Your Portfolio
11. 1. Look at the price-to-earnings ratio.
a) The P/E ratio, as it's abbreviated, can be figured as either the
stock's current price against its earnings per share for the last 12
months ("trailing P/E") or its projected earnings for the next 12
months ("anticipated P/E"). A stock selling for $10 per share that
earns 10 cents per share has a P/E ratio of 10 divided by 0.1 or 100;
a stock selling for $50 per share that earns $2 per share has a P/E
ratio of 50 divided by 2 or 25. You want to buy the lowest P/E ratio
you can.
b) When looking at P/E ratio, figure the P/E ratio for the stock for
several years and compare it to the P/E ratio for other companies in
the same industry and for indexes representing the entire market,
such as the Dow-Jones Industrial Average or the Standard and
Poor's (S&P) 500.
12. 2. Look at the stock's book value.
a) The book value, or shareholders' equity, is the
theoretical amount that stockholders would be paid for
each share owned if the company went out of business.
Stocks that sell close to or below book value are
considered cheap stocks.
b) Look at the reasons for the stock selling near or below
book value as well as the actual price. It may mean the
stock is undervalued and is a bargain, or it may mean
that the company is having trouble.
13. 3. Look at the return on equity.
Also called return on book value,
this figure is the company's income
after taxes as a percentage of its
total book value. It represents
how well the shareholders profit
their investment in the company's
success. As with P/E ratio, you need
to look at several years' worth of
returns on equity to get an accurate
picture.
14. Look at the total return.
4. Look at the total return.
Total return includes earnings
from dividends as well as
changes in value from the price
of the stock and provides a
means of comparing the stock
with other, non-stock investments.
15. 5. Evaluate the debt-to-equity ratio.
This ratio is the company's book value divided by its
debts. The more money the company pays in bond
interest or lines of credits with banks, the less it can
invest in its own future, protect itself from downturns or
pay dividends. Debt-to-equity ratios vary in different
industries and should be compared against other
companies within the same industry to gauge whether
the ratio is acceptable or excessive.
16. 6. Observe the stock's volatility.
a) How much the stock's price has changed in the past is a good
measure of how likely it is to change in the future. One measure of
volatility is beta, which compares the fluctuations of an individual
stock against those of an index such as the S&P 500. A beta of 1.0
means that the stock fluctuates as the index does; a lower beta
means it fluctuates less and a higher beta means it fluctuates more.
b) These 6 factors are known as a stock's fundamentals, and evaluations
using these factors are called fundamental analysis. Another way to
evaluate a stock is through factors such as previous price changes, the
ratio of advancing to declining stocks and other related statistics. This
form of analysis is known as technical analysis.
17. Tips.
You should review your portfolio at least once a year to
ensure that your portfolio is balanced correctly and that
the stocks in it are performing for you. At this time, you
should replace poor performing stocks with better
performers and adjust the ratio of stocks to take
advantage of changes in the market in the last 12
months. This is one of the services a brokerage firm can
handle for you if you choose not to do it yourself.
18. Warnings:
Be aware that not all common stocks pay dividends.
Whether a stock pays dividends should be only one
factor in choosing it, not necessarily the only factor.
