By Jack Hough March 14, 2012
Stock investors are caught between twin threats at the moment.
First, U.S. shares have produced wild swings but only meager gains for more than a decade. Deep economic challenges in the U.S. and Europe have left many investors wondering whether to leave the stock market altogether until things look better.
Second, those who sell their stocks face punitive yields elsewhere. On average since 1953, a million dollars placed in 10-year Treasury notes has provided more than $62,000 in yearly income. Today it provides $20,000. And money market rates are so low that savings placed in them lost about 3% to inflation over the past year.
Against such a backdrop, readers are eager for ways to improve their returns. One way is to select stocks that can outperform the market in coming years. A financial columnist is in an excellent position to help readers do that because, unlike some advice-givers on Wall Street, journalists don’t have incentives that go against investor interests. They’re not paid a percentage on trading fees, for example.
Also, journalists can gain access to the brightest people in finance. Much of my job at SmartMoney consists of finding researchers or money managers with good ideas on stock picking and writing about those ideas in a way readers can use.
Who should write about stock picking?
Every stock columnist should understand what’s at stake in their stories: the savings of ordinary people. Some of those people will follow the stock advice they read. The outcomes of those investments will affect things like whether they have enough money to pay for a child’s college education or for their own retirement.
Writers should take that responsibility seriously. An editor once told me to write like I’m explaining something to my grandmother. That’s good style advice. But write like your grandmother’s money is at stake, too.
That doesn’t mean always being right, of course. It means being sufficiently knowledgeable before you start and working hard to understand and explain the risks. It means being humble — Wall Street issues screaming buy lists, but columnists should offer stocks for further research.
At a minimum, a stock columnist should have a solid understanding of how to read company financial statements, which means being versed in corporate accounting. He or she should understand how economies are measured and how those measurements affect investor behavior. It won’t do to understand stocks but not bonds; a writer should learn about all of the investment choices open to ordinary investors. And he or she should know plenty about portfolio management, financial planning and taxes (for personal reasons, too).
I spent eight years working on Wall Street before I began writing. Not everyone will go that route, but real world investment experience helps. The top qualification, however, is endless curiosity about finance.
Why individual stocks and not low-cost index mutual funds?
Not everyone thinks stock picking is a good idea. John Bogle, founder of The Vanguard Group, a mutual fund company, favors indexing, or tracking the broad market rather trying to beat it. Warren Buffett, meanwhile, has found success doing quite the opposite.
My opinion: Mr. Bogle’s way is excellent for savers who have neither the time nor inclination to learn about stocks. Mr. Buffett’s way can offer an economic advantage to those willing to go after it.
Indexing was born out of academic research that suggested more than a half-century ago that stock picking is futile. The theory was that the market is so efficient that it doesn’t leave clues as to which stocks will produce better returns without extra risk. But in the years since, studies have consistently uncovered such clues – market anomalies, they’re called.
The best anomalies are simple. For example, shares that are inexpensive relative to measures of company prosperity – like profits, revenues, asset values and dividends – tend to outperform others, on average, over long time periods. Why? The reason has more to do with people than stocks. Investors tend to become overly pessimistic about some shares and overly adoring of others, and then change their minds as time goes on. Someone who follows the numbers and not the herd stands to profit.
How do you pick the stocks?
The method I use is called stock screening.
Step one is to find a clue that has been shown in rigorous research to produce good investment results. There’s a vast body of academic and practitioner research on the subject. Promising signs range from the simple (modest valuations) to the subtle (a surge in spending on product research, which bodes well for future earnings).
Step two is to use software to screen the broad market for companies exhibiting those clues. I use pricey but powerful software from companies like FactSet and Thomson Reuters. SmartMoney.com has a good stock screener that’s available to premium subscribers. Google and Yahoo have free screeners.
Step three is to explain the methodology and screen results to the reader.
It’s not quite as automated a process as that. For example, I’m careful to prune my screen results for signs of problems that rarely work out for the best – like companies with crippling debt. But stock screening adds structure to the process and forces me to have a concrete reason for highlighting the stocks before I begin.
Screening offers other advantages, too. It allows me to consider the entire universe of stocks rather than just the handful that investors are talking about now. And it helps me offer something of potential use to the reader beyond stock picks – a methodology.
What if you run out of stock picks?
In a universe of thousands of stocks, it sounds unlikely that a columnist would struggle to find a few good picks. But remember that a columnist who finds strong demand for his or her work will be asked to come up with fresh picks each week – and maybe more than once a week. That can quickly dilute whatever predictive power a stock strategy has to begin with.
That’s why it’s best to have other kinds of stock stories in the holster, too. Write about companies whose shares look too expensive (but be careful to offer sound reasons). Write a profile of one company’s stock, with a balanced explanation of the opportunities and risks. Write about the outlook for a particular industry. If the stock market looks expensive or cheap, write about why.
Jack Hough writes about investing for SmartMoney Magazine, SmartMoney.com and The Wall Street Journal. He’s the author of “Your Next Great Stock,” a guide to screening.
This entry was posted on Wednesday, March 14th, 2012 at 12:35 am. It is filed under On the Beat, Skills and Tradecraft and tagged with bonds, stock market, stock screen, stocks, Vanguard, Wall Street, Warren Buffett. You can follow any responses to this entry through the RSS 2.0 feed.
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