Choosing the best stocks can make the difference between earning or losing money. It’s easier to select a group of "buy" candidates than to decide which one of two stocks is best. Stocks can be compared on dozens, even hundreds of parameters. The key is to have five or six critical criteria you can apply in five minutes or less to make timely decisions.
Comparing Apples to Apples
Make sure the stocks you are comparing belong to the same industry group or at least the same category. It does not make sense to compare a stodgy utility to a fast-growing social networking stock. Each is good for its own purpose, but they have little in common. Stocks in similar groups are OK. For example, REITs, utilities and some financials are all good candidates if you are looking for dividend income. Stocks within a group often perform similarly, but different groups regularly go in and out of style with investors in a process called rotation. If you are comparing stocks from two groups, the one that belongs to a group that is currently in favor is more likely to outperform.
Every stock selection method can be reduced to five or six parameters that distinguish the best performers in their category. For example, the key drivers behind many fast-growing stocks are earnings and revenue growth. The best dividend paying stocks have the largest annual dividend increases and the lowest dividend payout ratios, or the ratio of dividend amount to annual earnings per share. Historical data can tell you how a stock has done in the past but have limited predictive value. It’s better to attach more weight to recent numbers -- the three quarters rather than the past five years – because recent trends are more likely to continue.
Tweaking the Model
If looking at the critical parameters does not give you a clear winner, you can add additional criteria to break the tie, or try to assign relative weight to the ones you have. The market favors different things at different times. For example, at one time it might favor large capitalization stocks. At another time, it might favor small caps.
Stock charts help you visualize performance by showing you which direction the stock price has been trending. Many online charting services let you compare two charts over various time frames. Some, like Yahoo! Finance, even let you add a major stock index and will calculate the percentage differences for you. You don’t need to be a chart expert to see which stock of two stocks has gone up the most or held its value better, much less whether it’s in an uptrend or a downtrend.
Make sure to compare consensus estimates for each stock. These represent the average of all analysts’ sales and earnings projections for the next year or two. Although estimates are opinions that can change, stocks trade on future expectations. Just beware of stocks that have a recent history of falling short of quarterly sales and earnings estimates. Stocks tend to get punished when they don't perform as expected financially.
Lower priced stocks, or those that range from $3 to $10 per share, tend to fluctuate in price more than higher priced stocks that trade from $50 to $100 per share. Price alone won’t give you a winner but will help you decide how much risk you want to take when choosing between two stocks.
- FINRA: Stocks
- How to Make Money in Stocks: William O’Neil
- One Up on Wall Street; Peter Lynch