Money Essentials

Picking the best stocks for your portfolio

Picking the right stock for your portfolio is more than eeny, meeny, miny, moe

Although there are more than 6,000 publicly traded companies, the core of your stock portfolio should consist of financially strong companies with above-average earnings growth.

Surprisingly, there are only about 200 stocks that fit that description. A well-balanced stock portfolio should consist of 15 to 20 stocks, across seven or more different industries -- but you don't have to buy them all at once.

Since you want to be able to hold your stocks for a long time, they should offer a total return higher than the 10% historical market average. You can estimate the likely return by adding the dividend yield to the projected earnings growth rate -- a stock with 11% earnings growth and a 2% yield could provide a 13% annual total return.

As a general rule, stocks with moderately above-average growth rates and reasonable valuations are the best buys. Statistically, high-growth stocks are usually overpriced and have a harder time meeting inflated investor expectations.

The first thing to look at is the stock's price/earnings ratio compared with its projected total return. Ideally, the P/E should be less than double the projected return (a P/E of no more than 30 for a stock with 15% total return potential).

A well-balanced portfolio might include a couple of industrials with 9% growth rates and 3% yields, selling at 17 P/Es, as well as consumer growth stocks with 13% growth rates and 1% yields, at 23 P/Es. Add a couple of tech stocks with 25% growth rates and high P/Es (don't overdo it on those).

If you can average a 14% return over the next 10 to 20 years, you'll reach your financial goals -- and probably outperform most pros as well.

Sivy 70: America's Best Stocks
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