Adding Stocks to Your Portfolio

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Adding Stocks to Your Portfolio

After assembling and monitoring your portfolio of mutual funds, you may make a discovery: you like this investing stuff. Maybe you want to be your own fund manager—maybe you want to start investing in individual stocks.

In fact, investing isn’t an either-or process; you don’t need to be either a fund investor or a stock investor. You can be both.

Once you’ve developed your portfolio’s core, feel free to break out of mutual funds and dabble in stocks. Stocks can be great tax-management tools. Mutual funds can cause tax headaches. But stock investors get to decide when they take gains (or losses), and thereby determine their own tax destinies. You could, for example, defer gains if you choose, or sell a losing position to offset distributed gains in your funds.

If you decide to try your hand at stocks, where do you begin? Here are some of the key factors to consider.

Growth

Look for companies that are able to increase the size of their businesses consistently over time. In particular, look at how fast sales have grown relative to other companies in the same sector. Take into account the trend in sales growth—whether it’s speeding up or slowing down—and its consistency during the past five years.

Profitability

Consider companies that earn consistently high returns on the money entrusted to them by shareholders. Examine the absolute value of a company’s return on assets (ROA), a key measure of how well a company uses investors’ money. Also look at the trend in those ROA ratios and their consistency.

Financial health

Companies that keep debt low and generate cash every year could be worthy of your attention. Assess the strength of a company’s balance sheet and the level of its free-cash flows.

Valuations

Size up a stock’s price relative to others in its industry and the broad market.

Economic moat

What are the company’s competitive advantages? Could similar companies readily steal market share?