The infamous stock tip. It can make or break friendships, create or destroy wealth, and ruin an otherwise lovely dinner party. I mean, there's nothing more uncomfortable than being cornered by a guy with spinach dip in his teeth preaching that airline stocks are the place to be.
I must admit, however, that some of my best stocks have reached me by word of mouth.
So how do you tell the difference between a good tip and a bad tip?
In three easy steps ...
Step No. 1: Ask the tip-giver to summarize the company's business in 30 seconds. If he or she can't do that, try to change the subject as quickly as possible. "Hey, how about them [insert local sports team here]," always seems to work.
Step No. 2 (assuming Step No. 1 has been satisfied): Ask them to name one catalyst for the business (e.g., increasing margins, new market opportunity).
Step No. 3: Trust, but verify. If you're intrigued by what you've heard, review the company's SEC filings, determine the stock's proper valuation, and if it is more than the current market price, consider buying shares.
The good, the bad, the ugly
During the past year, I've been given some great -- and not-so-great -- ideas. Let's take a look at why some worked and some didn't.
|
Company |
52-Week Return |
What's Behind the Performance |
|---|---|---|
|
Norfolk
Southern |
19.0% |
Double-digit ROE, increasing dividends. |
|
Core Labs |
152.3% |
Surging FCF, benefited from high oil prices. |
|
Merck |
52.5% |
Despite Vioxx woes, series of positive EPS reports exposed this value play. |
|
Gilead
Sciences |
53.5% |
Success of Tamiflu and HIV drugs fueled revenue growth. |
|
Gap |
-6.7% |
Shrinking comps and miscues on fashion trends led investors to question Gap's future profitability. |
|
Blockbuster |
-42.7% |
Losing market share to online rental juggernaut Netflix |
I know you're thinking it's easy for me to look at these stocks in hindsight and say why one succeeded and another flopped. That may be true. But a year ago I could have looked at Blockbuster's income statement and seen reduced margins and profits, while Gilead Sciences was making profits hand over fist. Those, at least, were two tips worth researching further.
Foolish bottom line
When you get stock tips from friends, family, or even complete strangers, you need to separate the wheat from the chaff. Following the three steps I outlined above will help. Remember that most of the tips will be rubbish, but once in a while a worthy idea will cross your path.
If you're looking for tips and research for your portfolio, consider a free 30-day trial to Motley Fool Stock Advisor. Fool co-founders David and Tom Gardner search for top-notch businesses poised to outperform the market for years to come. Their strategy has proved successful -- since the service's inception, the brothers' picks have outpaced the market by 35 percentage points. And, unlike most stock tips you'll receive, they support their recommendations with financials and drivers that fuel the company's growth.
Interested? Follow this link to grab your free trial to Stock Advisor.
At the time of publication, Todd Wenning owned shares of Core Labs. Netflix and Gap are Stock Advisor recommendations. Gap is also an Inside Value choice. Merck was once an Income Investor choice. The Fool has a disclosure policy.
