The Independent Market Observer

1/24/13 – How to Invest in Stocks

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jan 24, 2013 11:05:02 AM

and tagged Economics Lessons, On My Bookshelf

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With the economy recovering, the market doing well, and the politicians seemingly getting down to the business of actually negotiating rather than yelling at one another, people are feeling more cheerful, especially about the stock market. Investor surveys are at very high levels for confidence, volatility is at historically low levels, and U.S. markets are closing in on all-time highs. What’s not to like?

Actually, there are a lot of reasons to be concerned—which I have written about in the past and will do so in the future—including the fact that high levels of bullishness are themselves contrary indicators. Today, however, is about how to invest in individual stocks, rather than about the market as a whole, and here there are encouraging signs.

One of the best signs for stock pickers is the decreasing correlation among the performance of individual stocks. Since the financial crisis, stocks have tended to move together to a much greater degree than in the past; as a result, stock pickers, or active managers, could not get any traction since their presumed good stocks were going to act the same as the bad stocks. In other words, the action of the market as a whole trumped the facts about any individual stock, so you couldn’t make money off an individual stock’s outperformance.

This is now changing, with correlations coming down and investors starting to focus on individual stock characteristics, which should mean that stock pickers will again start to add value. It also means that it may now be time for investors to start looking at individual stocks. Note that I still have concerns about the market as a whole, but given current market conditions, looking at individual stocks can make more sense than it has in a while.

There are thousands of books on the stock market and investing, and I certainly have not read all of them, but I have read a bunch—here are a few that I believe are worth a look.

The first, and probably the best for people who are starting out, is The Intelligent Investor, by Benjamin Graham. The bible of value investing, it also is recommended by Warren Buffet, who said that it is “[by] far the best book on investing ever written.” Hard to argue with that.

For people who are looking for something a little more prescriptive, I like William O’Neil’s How to Make Money in Stocks. This gets away from the fundamentals presented by Graham and goes into what O’Neil sees as the actual characteristics that define a winning stock. His CANSLIM methodology gives a framework for evaluating stocks and the market as a whole that’s worth a look.

Finally, James O’Shaughnessy’s What Works on Wall Street adds a lot of value by identifying different factors that can make money in the market and analyzing when and how they do so. This is not a book to read cover to cover, but rather to look at when you are considering different stocks and how best to compare them. Not everyone will like or agree with O’Shaughnessy’s approach, but I believe it adds a layer of deliberate thought in terms of which factors work that I have found valuable in my own analyses.

There are many more books I could and do recommend, but these three provide different looks at ways to consider the market. I own all three, in multiple editions, and go back to them periodically to refresh my knowledge.

Tomorrow, I will discuss different ways to apply the knowledge and methods in these and other books.

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