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How to become a successful stock investor

The key to becoming a successful stock investor is to know the difference between a great investment and a bad investment. Many investors assume that great companies are great investments, but this is not always an accurate assessment. Sometimes, a wonderful business can make a lousy investment.

Most stock investors can be classified into two investment styles: value and growth. Value investors utilize an investment style that favors good companies at great prices over great companies at good prices. These investors use such valuation measures as price-to-book ratio, price-to-earnings ratio, and dividend yield to determine the attractiveness of an investment. Growth investors invest in companies that are growing their earnings and/or revenue faster than the industry or the overall stock market. These companies usually pay little or no dividends, instead preferring to use profits to finance future expansion and growth. Value investors prefer to own companies at good prices, and growth investors prefer to own great companies and price is a secondary issue.

Which style is better? It depends on the investor. Stock investors with a lower tolerance for risk should consider investing a larger portion of their portfolio in value stocks. Investors with a higher tolerance for risk should consider investing a larger portion of their portfolio in growth stocks. However, investors who want to avoid under performing the stock market as whole should always invest at least a small portion of their portfolio in both investment styles.

Over the long term, value has outperformed growth, but from time to time growth has outperformed during the short term.

Stock investors should be aware of the following:

1. The stock market rewards different styles at different times.

2. Value investors tend to be buy-and-hold investors, and growth investors tend to be more short-term oriented.

3. It is very difficult to determine which style will outperform in the short-term.

4. The variance between performance of value and growth styles can be very large during short time frames.

5. For some growth stocks, growth never does come. Eventually the share price falls.

6. Some value stocks are cheap for a reason - they are bad stocks and they deserve to be cheap.

Overall, the best investments are those companies that able to grow profits and add shareholder value. These companies have traditionally been value companies. Investors who prefer to select their own stocks should consider a value approach and complement these investments with a growth mutual fund. Remember that selecting the wrong growth company is not as forgiving as selecting a value company erroneously, as the market correction in growth stocks in early 2000 showed us.

by: Daniel Reed
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