Recs

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Step 6: Discover Great Businesses

When you buy a stock, you're purchasing a stake in a living, breathing business. Buy shares of your favorite fast-food joint and you own the place. Literally. Every time someone gets fries with that shake, a tiny bit of cash drops to your company's bottom line. High five, shareholder!

Finding great stock ideas is as simple as opening your eyes. Your fridge, medicine cabinet, wallet, computer: all hotbeds of stock ideas. Behind virtually every successful product or service lies a publicly traded company that's cashing in on that success -- and that you can join as a business partner.

Better know a better business
But a great service or product does not a great investment make -- just ask anyone who invested in Webvan during the dot-com era. (Never heard of it? Yeah, that's kind of our point.) Again, think of buying shares of a company just like buying a stake in a local small business. Does the business have staying power? How much cash flows in and out? Do you trust the management and employees to do right by you as an outside investor? Hardly questions you'd need a Harvard MBA to spell out for you, right?

Fools take the same commonsense approach to investing. We're interested in the strength of a business. Not past performance, charts, or whether the shares have split.

Specifically, here are a few things we look for:

  1. A sustainable competitive advantage: Some businesses have unique, lasting competitive advantages that allow them to earn outsized profits. The more durable a company's competitive advantage, the larger the "moat" that surrounds its financial fortress. ADP's scale and high switching costs, eBay's network effect, and Johnson & Johnson's intellectual property are all classic examples of sustainable competitive advantages.
  2. Cash aplenty: Cash is the lifeblood of any business. It pays the bills and covers the tab for new growth projects. Fools look for low-debt, cash-rich balance sheets and steady cash flows.  Specifically, free cash flow -- the cash left over after funding operations and growth -- fuels share repurchases and those sweet, sweet dividends that show up in your brokerage account every three months.
  3. Strong leadership: Is management invested alongside you? Do they have a history of creating value for shareholders? Do they have years and years of relevant experience? Do they treat outside shareholders (business partners) with respect?

If you stumble across a company that nails all of the above, odds are good that you're looking at a great candidate for your hard-earned cash. So you've done your homework. Now what?

Cheat. Yes, cheat.
Thanks to this wondrous Internet-thingy, getting second opinions on stock ideas is just as easy as finding the ideas in the first place. Turns out there are legions of investors just like you freely sharing their ideas, thoughts, and research. Here's where you can find them:

  1. Motley Fool CAPS: Looking for a second opinion? How about a few thousand of them? CAPS harnesses the power of collective intelligence to provide ratings on just about any stock you could name. Stop by to read comments from other investors and see which stocks they think are the best -- and worst. Even better, CAPS is full-on free, Fool.
  2. Fool discussion boards: According to the lore of Foolish yore, The Motley Fool got its sea legs by connecting like-minded Fools through discussion boards. Today, Fool.com is host to thousands of investing-focused boards. Portfolio Management? Check. Living Below Your Means? Check. Ask a Foolish Question? Another check. And just like CAPS, our boards are 100% free.
  3. Fool Premium Services: From international stocks to small caps to dividend payers, The Motley Fool offers a range of premium stock-picking services where we do the work for you. Try any of them free with a 30-day trial.

With so many ideas and resources at your fingertips, you've lost any excuse not to start digging in and rating stocks yourself. So get on with it!

Action: Earn your jester cap -- and a CAPS rating. Head over to Motley Fool CAPS and rate your first seven stocks!


Read/Post Comments (13) | Recommend This Article (386)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 18, 2011, at 3:33 PM, mountain8 wrote:

    Meant to be humor of a sort - If I follow the ideas of a couple hundred thousand contrarians, Am I just following the herd?

  • Report this Comment On July 28, 2011, at 2:09 PM, sgperformer wrote:

    Yes, but that's not necessarily a bad thing to do.

  • Report this Comment On January 30, 2012, at 12:02 AM, JoshuaNyc wrote:

    Warren Buffet does the same research. Correct me if I'm wrong.

  • Report this Comment On March 10, 2013, at 10:07 PM, cczou wrote:

    Just buy one share of stock - that sounds more applicable for beginners like me, I suppose? but can anyone tell me which online broker would allow me to just buy one single share of a company and not do any trading over a long time (like 6 month or a year), just to learn more about the stock? Which broker would do that without any "low activity" penalty? Any suggestions?

  • Report this Comment On April 15, 2013, at 6:50 PM, briefrespite wrote:

    what do you think of questrade?

  • Report this Comment On July 08, 2013, at 2:12 AM, warreneng wrote:

    @cczou:

    I use Scottrade. I poured over their fine print and didn't find any fee outside the cost of the trade ($7 commission). I'm sure there are other online brokers that are similar.

  • Report this Comment On October 21, 2013, at 11:31 AM, alawrence37 wrote:

    Is there somewhere I can find a business rules engine like http://www.decisions.com ? What exactly would they be able to help me with? I own a small café and really want to try new things to make it more popular. Any tips?

  • Report this Comment On February 21, 2014, at 11:39 PM, weave wrote:

    I am just starting to research how to buy stocks and would like to know, I have 300 dollars to start and only 25 dollars a month there after to invest would that be enough to make good money over a 10 year period and if so what is my best way to go about this with this concept ?? I really want to do this so please any help would be very helpful because I really don't understand everything to get started...

    Thanks for any help.

  • Report this Comment On February 25, 2014, at 6:31 PM, YoungInvestor wrote:

    First of all congrats on getting started. Any amount no matter how small goes a long ways when saved over a long period of time.

    I would refer you to Step 4 of this sites 13 steps. You are currently commenting on Step 6. It should provide you with some basic knowledge on how to get started.

    Here is a quick link to it

    http://www.fool.com/how-to-invest/thirteen-steps/step-4-open...

    Once again congrats !

  • Report this Comment On February 25, 2014, at 6:35 PM, YoungInvestor wrote:

    In fact it may be more beneficial to start at step 1 if you haven't already.

    Step 1:

    http://www.fool.com/how-to-invest/thirteen-steps/step-1-chan...

  • Report this Comment On June 03, 2014, at 1:52 AM, Investermind wrote:

    To be honest if you have a talent you should focus on how to build it rather that taking huge risks. communication is the key. Mo Works creative agency located in Docklands, Victoria talks in you language and help you find your competitive advantage and grow it. check the website out www.moworks.com.au

  • Report this Comment On June 30, 2014, at 7:54 AM, alex80 wrote:

    Step 6 requires special capabilities and special knowledge. This contrasts with all other statements you make.

    Did I miss the main bible point of investment: buy an index fund. Make sure it is really cheap with expenses not more than 0.2%. Start with S&P500.

    You could diversify it with another index fund for income. And another one for something else, value for instance. Do not do anything fancy.

    Stop reading foolish recommendations.

    You will be ahead of 90% of investing crowd, including professionals.

  • Report this Comment On August 21, 2014, at 11:49 PM, spaulson wrote:

    So I could use my return from say a (mutual investment of 2000) can I use the return of that after 1 year and invest that. Or does it automatically do that. and also can two mutual investors buy a put option share starting out.

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