As we discussed in Chapter 3, the primary goal of your first stock is to get you started investing. Above all, this first stock must:
- Be interesting to you
- Have financials and a business strategy you understand
- Be a company you’ll enjoy following and talking about with fellow investors
We’ll take you through all the steps from Chapter 3 to help you identify the perfect first stock for you.
Step 1: Identify 10-12 companies whose products or services you and your family and friends use frequently.
You’ll need to know their ticker symbols as well. You can easily find those using a Google search (just type “ticker” followed by the name of the company).
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Step 2: Cross off any that don’t have at least $75 million in pre-tax earnings.
To find this information, go to fool.com and type the ticker symbol in the box at the top of the page, then click the “Get Quote” button. Click on the “Statements” tab and look for the “Pre-tax Income” line on the Income Statement. If the number is 75 or higher, that stock makes the cut.
Step 3: Cross off the companies that have not been profitable for the past five years.
The easiest way to check this is to go to moneycentral.com, type the ticker symbol in the box at the top left and click the “Get Quote” button. Click the “Financial Statements” link under the chart, then go to the “10-Year Summary” tab and look at the “EPS” column. You want to see a positive number there for the top five entries.
Step 4: Delete any that don’t have a return on equity of at least 10%.
To find this head back to fool.com and type the ticker symbol in the box at the top of the page, then click the “Get Quote” button. Click on the “Profile/Key Stats” tab and look for “Management Effectiveness” in the right column. You’ll find Return on Equity there.
Step 5: Cross off companies with too much debt.
Click over to the “Ratios” tab on fool.com and scroll down until you see “Financial Strength.” The Interest Coverage Ratio is listed there – you want to be sure it’s 1 or higher.
Step 6: Fire any management teams that don’t measure up.
There’s no substitute for quality management that’s committed to the company and to shareholders. Unfortunately, there’s no one way to judge management, but a little poking around on Google can give you a general feel for how the management team is performing. Here are a few things to look for:
- Is the founder still active in the company?
- Do insiders have an ownership stake in the company? (Find this at finance.yahoo.com – enter the ticker symbol in the box in the top left corner of the page, then scroll down to find “Insider Transactions” toward the bottom of the blue bar on the left side of the page. Click that link to see what percentage of the stock is held by insiders and whether they’ve been buying shares recently or selling them.)
- What’s their compensation?
- How long is their tenure?
- Are they smart? Look for the boards the CEO serves on, where he or she went to school, and whether he or she is considered a leader in their industry.
After digging around a bit, cross off any companies whose management is questionable.
Step 7: Describe the company’s business model in one sentence.
You want to invest in companies that you understand, so that you can quickly spot any changes to their core business strategy (say, Wal-Mart merges with Tiffany or Netflix starts renting out snowmobiles). If you can’t sum up the business in a sentence or two, cross that company off the list.
Step 8: Invest!
The companies that are still on the list are strong contenders for your first stock. So what are you waiting for? Go invest! If none of your companies made it through our hurdles, just start with a new list. It’s worth taking the time to find the right stock for your first investment.