Most beginning investors start with Peter Lynch's suggestion of buying what they know. Buying stock in one or two of your favorite companies is fine to start with, but you have to diversify, especially in a volatile market like this one. It doesn't take much for one single stock to come crashing down, no matter how much you love it. (*cough* Netflix. *cough*)
With thousands of publically traded companies out there, though, diversifying can be overwhelming. Here are three parameters I use to help narrow the list:
1. High inside ownership: I get excited when I see a company with 20% or higher inside ownership, but even just 5% is a good sign that the company is backed by a leadership team dedicated to the company's future performance. As investors themselves, they're much more likely to make decisions that will benefit all investors, like using extra cash to pay out a dividend.
2. A dividend: While a dividend yield of 5% or higher is eye-catching (and double digits are thrilling!), any dividend at all proves a company's reliability, and I'm not picky with my free money. Companies that pay dividends typically have strong, consistent cash flows, which is a sign of good management and financial well-being -- exactly what we want for our portfolios, right?
3. Recognizable brand: This is the most subjective of the three criteria, and also possibly the most controversial. Sure, there's something to be said for finding the lesser-known underdog of an industry, silently chugging along with its unnoticed profits, but I prefer a company with an already-established brand. Once a strong brand is in place, the company has an edge that's hard to bring down (think Coca-Cola).
Let's watch it all in action
As I read articles throughout the day, I keep a list of stocks that sound interesting to me. When the list starts to get too long, I run them through my filter to keep it manageable. Here are my three most recent finds:
Next up, Wynn Resorts
The final company to make the list was Royal Caribbean Cruises
After further research (reading the companies' 10-Ks and press releases, and really digging into those financials), Royal Caribbean is definitely my favorite of the three companies here. It has navigated its way through the recession pretty well, and is poised for international growth.
Adding it up
Luckily, it wasn't a long road to find a company I'd feel confident investing in, thanks to my three-step filter. It's a good idea for all investors to decide what metrics are meaningful to them when choosing new stocks to research. But if you're only looking to add one stock to your portfolio in the upcoming year, then click here to read "The Motley Fool's Top Stock for 2012." The report is completely free, and this stock should definitely make its way onto your short list.