Choosing Your Investment Strategy

You’re interested in investing, you want to get started, but how do you choose which stocks to buy? There’s the American Stock Exchange, the New York Stock Exchange and the Nasdaq, plus foreign stocks. Tens of thousands of companies to choose from, so how do you distinguish the good ones from the bad?

Everyone has a theory or strategy. Some share their strategies such as Peter Lynch, Warren Buffet, and the Gardner brothers. Others follow principles such as the Dogs of the Dow. I’m going to cover two strategies I like. The first is from the Gardner brothers, they run The Motley Fool and have several different strategies, including the Rule Maker. The second theory is the Chicks Dozen, a strategy used by a womans investment club at Chicks Laying Nest Eggs. The Chicks Dozen is a combination of Peter Lynch, Warren Buffet and the Gardner brothers philosophies. How you choose stocks is ultimately up to you, but learning from other people’s strategies will help you along the way, especially if you are starting out not knowing anything. The other great way to learn is to start an investment club of your own.

Motley Fool’s Rule Maker

1. The company must have at least one sustainable competitive advantage. A competitive advantage is something that staves off competition such as patents, trade names, or well known brands.
2. Great management with a track record of excellence. You want to know who is running the company and that they will do the right things.
3. Expanding possibilities. A company that can create new products or services has room to grow.
4. Annual sales growth of at least 10%.
5. Gross margins greater than 50%. Gross margins is the amount of profit that a company makes when selling an item. So if an item costs $10 to make and they can sell it for $20, they make 50%.
6. Net profit margin of at least 10%. Net profit is the amount the company makes after all of it’s expenses, including marketing, salaries, etc.
7. Cash king margin greater than 10%. This is similar to net profit margin, but rather than using net income from the balance sheet, you use free cash flow from the cash flow statement and divide it by sales.
8. Cash no less than 1.5 times the company’s total debt.
9. Foolish flow rate no greater than 1.25. The flow rate shows how efficiently a company uses it’s cash and is determined by taking the current assets minus the company’s cash and dividing that number by current liabilities minus the company’s short term debt.
10. Reasonable purchase price for clear possibility of 2x/5y. The stock price has to be reasonable enough to expect you to be able to earn twice that amount in 5 years.

Chicks Dozen

1. Buy what you know. Understanding the industry in which you are buying stock is important. By understanding the industry you will have an edge in seeing what may happen in the future and be able to understand press releases and news stories about the company.
2. Keep It Simple Sister. You should be able to explain the company and industry to a ten year old.
3. Industry. Know the industry, if it’s emerging or declining. You wouldn’t buy stock in a buggy company now that cars run the roads.
4. Leader in it’s field. Is the company the first or second name you think of when the industry is mentioned?
5. Repeat profitability. Do customers need the service or product over and over again?
6. Gross margins at least 50%. Gross margins is the amount of profit that a company makes when selling an item. So if an item costs $10 to make and they can sell it for $20, they make 50%.
7. Cash no less than 1.5 times the company’s total debt.
   Net profit margins at least 8%. Net profit is the amount the company makes after all of it’s expenses, including marketing, salaries, etc.
8. Flow ratio no great than 1.5. See explanation above.
   Increasing growth. The chicks don’t have a set percentage like the Motley Fool’s do.
9. Strong management.
10. On sale. Is the stock price lower than the 52 week average? While the Chicks don’t like to watch the market, they are long term holders, if you are trying to choose between stocks and the last factor is price, go with the sale! We’re women after all!

You can see that the strategies are very similar, which is probably why I like both of them. They may not work for everyone, but it’s a starting point to see how other people are evaluating stocks. So where do you find all of this information?

For a company’s financial information, for determining things like gross margins you can research at FreeEdgar.com. Once you start researching some companies, take advantage of our portfolio tracker, you can “buy” stocks and test different strategies before you start investing actual money!