Friday, June 04, 2010

What Makes a Good Stock?

I suppose there is a simple answer to the question: "What makes a good stock?" A good stock is one that enables us to make a profit. By that definition, a stock whose price is dropping dramatically can be a good stock for us if we have shorted it or bought puts on it or in some fashion have set up a trade that is designed to make money when the stock price falls. If not a good stock, it is at least one that provides a good result. On the other hand, I am aware that many, if not most, retail traders seek stocks that are going up in price. They are bullish by nature and define a good stock as one that is increasing in price. For the purposes of the remainder of this article, I'll go along with the idea that a stock making a bullish move or one in which we can profit from a move to the upside is a good stock.

The next question, then, is what makes a good stock. All too often in my view, retail traders and investors confuse a good company with a good stock. If we look back over the last 5+ years (beginning January 2005), as an example, we can see that there are many good companies that simply have not had good stock as defined by an increase in value over the period. Take the Dow 30 Industrials for example. The companies in the Dow are well known and the index is followed by almost everyone who pays any attention at all to the markets. These companies are generally regarded as giants in their respective fields, but how have they done over the last 5 years? In terms of capital appreciation have the Dow 30 been good stocks during that period? Looking, for the moment, at those that have not split during those last 5 years, we can see that as of June 1st, many are trading at less than they were at the beginning of 2005. Among those that are down from their price at the beginning of 2005 to the time of this writing on June 1st are: AA, AXP, BAC, DD, GE, HD, INTC, JNJ, KFT, MMM, PFE, T, and VZ. Some like JPM and MSFT are trading near the same price they were trading back at the beginning of 2005. In other words, even after the relatively strong run-up from March, 2009 to the present about half of the Dow, arguably some of the best and strongest companies in the world, stood still or lost ground.

The only conclusions I draw from those facts are that a good company is not necessarily a good stock (in terms of capital appreciation over a given period of time) and buying and holding even great companies may leave the investor very disappointed over time.

Obviously there are other elements besides capital appreciation that a given investor or trader may consider when defining for himself what may be a good stock. Certainly, perceived safety may be a consideration as might be the frequency and yield of dividends. So much of the definition of what is a good stock must come from the goals as incorporated into the plan of an investor. It may be that some investors don't care whether the stock they own falls in price over a 5 year period as long as they are receiving regular dividends and can write out of the money covered calls to bring in income while for others it may seem inappropriate to hold a position that is going the wrong way over a 5 year period.

Once again, it comes down to the individual's trading business plan as I have so often emphasized here and about which I have written relatively extensively in both "Trade Your Way to Wealth" and in "Smart Investors Money Machine." My purpose in this article is merely to suggest that defining a "good" stock depends upon who is doing the defining. It is probably a worthwhile effort to take the time and trouble to understand the elements of your own definition.

by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved

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