In a previous post, I talked about how I think about growth stock and dividend stock. It's an important distinction to make, and you need to understand the difference between the two and decide which kind - if not both - you want in your portfolio.
The second question to ask, of course, is: Which stock should I buy? It's a tricky question, and one that requires you to make a number of very specific decisions and choices in order to get a clear answer to. It took me a while, but I have a couple of criteria which have served me well so far, and I'd like to share them with you here:
First of all, I don't buy stock in a start-up or a company that just went IPO. There's just too much inherent risk even if the potential wins are massive. For every startup that makes it big, there are dozens that are belly-up within just three years. For every IPO that has consistent and regular growth, there's another that flops and behaves erratically on the market for several months.
That's why I want to see a company that has been in operation for at least five years since becoming tradeable, preferably even more. Facebook (NASDAQ:FB) and the like are off the table entirely, but companies like Pfizer (NYSE:PFE), Wells Fargo (NYSE:WFC) and Monsanto (NYSE:MON) all qualify.
Even though they might be good growers, I rarely invest in companies with a very narrow niche market unless they have a de facto monopoly that will be extremely hard to shake. For example, I didn't for a second consider buying GoPro (NASDAQ:GPRO) stock because I know that all that needs to happen is for another company to release a competing device of superior quality or at a significantly lower price. Since GoPro really only compete in one extremely small market, it's going to be hard for them to keep a steady growth for many years to come; there will be competitors who turn them down a peg. Sure; the money might be good until then, but it's not very reliable.
Instead, I invest in companies that exist in many markets. My favorite example, as so often before, is Disney (NYSE:DIS). They have movies, television studios, merchandise, theme parks and plenty more to offer. Even if one market slows down (theme parks during winter, for example), the remaining markets still push the growth. They also own many of the best known franchises in the world, like Mickey Mouse, Marvel, Star Wars and Pixar. Similarly, companies like Coca Cola (NYSE:KO) or Johnson & Johnson (NYSE:JNJ) are extremely diverse and have no immediate weaknesses in terms of being pushed out of the market.
I also like seeing that the companies I invest in have been consistently profitable. That means that during the past five years, I need to see that at least three of those years have been profitable and that the average yearly change is at least 5% - less so if it's quite obviously a dividend stock.
I understand that past trends are no guarantee for future trends, but it does set your expectations.
I have a couple of other criteria, of course, but those three are essentially the main ones. I'll go into more detail as to which individual companies I've picked at a future date and explain my reasoning.