Back to the Basics: Finding Great Stock Ideas

So far in this series, I've turned off CNBC, stepped back from the daily clamor of the markets, and reviewed some basic investing concepts. In my first article, I got just about as basic as it gets by reviewing what exactly a stock is. In the second part, I took a look at why investors would want to buy stocks and what type of investor should attempt investing in individual stocks.

For those investors that are set on digging into the market to try and find the best individual stocks, today I'm going to look at a couple of ways to find potential winners.

Buy what you know
At this point, this is a market saw that can cause as much heartache as it can good. The idea of buying what you know was thrust into the mainstream by Peter Lynch. HanesBrands -- prior to its acquisition by and spin-off from Sara Lee -- was a famous Lynch success story. Lynch was led to Hanes by his wife's rave reviews of a new product, L'eggs. He followed the product to the parent company, liked what he saw, and ended up with a stock that appreciated 30-fold.

Following Lynch, looking around at where you shop, what you buy, and what services you use can be a very useful strategy. Investors who were thoughtfully munching on Chipotle (NYSE: CMG  ) burritos early in that company's history may have seen the opportunity to expand its offering of fresh, high-quality Mexican food all over the country. Similarly, early adopters of Green Mountain Coffee Roasters' (Nasdaq: GMCR  ) Keurig coffee maker who appreciated the simplicity that the device brought to home coffee brewing could have scored some impressive gains by investing in the stock. In large part, their success came from their rising popularity among their customers.

Whether it's strolling around the local mall, keeping an eye on what your kids are wearing and playing with, or taking a closer look at what's in your grocery basket, stock ideas are all over the place.

But like I said above, this simple-sounding method of finding stocks can be problematic. Investors that never get beyond "Everyone seems to love X" and don't really understand how the company in question functions or what its financials look like can get themselves into trouble. Likewise, some of the hottest products can turn out to be little more than fads that will burn investors when the fascination of fickle shoppers cools. Just ask Crocs (Nasdaq: CROX  ) investors about that.

"Buy what you know" may be the most straightforward of the strategies we'll look at here, but like both of the others, it's just a starting point, not a full investment thesis.

Buy what you read
Like money, great investment ideas don't grow on trees. For that reason, the best investors are always on the prowl for new ideas and that means most of them are voracious readers. Superinvestor Warren Buffett, for example, has a daily ritual of reading a pile of newspapers that includes The Wall Street Journal, Financial Times, The New York Times, USA Today, and the Omaha World-Herald.

While some news articles may be specifically aimed at providing investment ideas -- particularly from sources like the Journal -- others provide general news and analysis that can be the raw material for investment ideas.

As a simple example, The New York Times DealBook blog covered the fourth-quarter earnings of private equity firm Blackstone (NYSE: BX  ) last week. The company reported stellar earnings that were up 56% from the prior year, and it indicated that it has plenty of investable capital that it can use for new investments this year. The article's author also highlighted the fact that Blackstone CEO Steve Schwarzman conducted the conference call from the company's Paris office, where he will be based for four months focusing on Blackstone's international business.

We can do a few things with this. First, we might want to take a closer look at Blackstone competitors like KKR and Fortress Investment Group. If Blackstone's results were so good, perhaps others in the industry have seen better fortunes as well -- both KKR and Fortress report earnings later this month.

Considering the amount of investable capital that Blackstone and other private equity firms have, this could also be a good reason to look around for potential buyout candidates. Private equity firm Leonard Green has been particularly active lately, having agreed to buy Jo-Ann Stores and take part in the buyout of J. Crew Group, as well as being the likely suitor for a BJ's Wholesale (NYSE: BJ  ) privatization. Investors in the right places could find quick gains from private equity deals.

Finally, Schwarzman's presence in Paris may be good reason take a look at opportunities in Europe. It seems particularly interesting to me that Paris was chosen when the company also has international offices in places like Dubai, Mumbai, and Beijing.

This is just a simple example from a single article. Imagine the number of ideas you could come up with from reading through a few full newspapers.

A good place to start
Investment ideas are the lifeblood of any investor, and so it follows that it's tough to succeed at investing without any good ideas. The two methods above certainly aren't the only ways to find investment ideas -- I'll show you another one next time -- but they're a good place to get started.

Of course, as I noted above, it's important to remember that these are only ideas. In future installments of this series I hope to walk through the process of taking these ideas and figuring out whether or not they make worthwhile investments.

So I hope you'll get started rounding up a bunch of great investment ideas, and until the next installment, I'd love to hear from you in the comments section below with questions about this article or thoughts on what you'd like to learn in future articles.

Chipotle and Green Mountain Coffee Roasters are Motley Fool Rule Breakers selections. Motley Fool Alpha has opened a short position on Green Mountain Coffee Roasters. The Fool owns shares of Chipotle, which is also a Motley Fool Hidden Gems recommendation. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of Blackstone, Intel, and Johnson & Johnson, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


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