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Picking stocks for your portfolio
In Lesson 5
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Money 101 Lessons
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Adapted from Michael Sivy's "Sivy on Stocks" column, "Low-risk growth investing."
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 percent historical market average. You can estimate the likely return by adding the dividend yield to the projected earnings growth rate - a stock with 11 percent earnings growth and a 2 percent yield could provide a 13 percent 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 percent total return potential).
A well-balanced portfolio might include a couple of industrials with 9 percent growth rates and 3 percent yields, selling at 17 P/Es, as well as consumer growth stocks with 13 percent growth rates and 1 percent yields, at 23 P/Es. Add a couple of tech stocks with 25 percent growth rates and high P/Es (don't overdo it on those).
If you can average a 14 percent return over the next 10 to 20 years, you'll reach your financial goals - and probably outperform most pros as well.
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