Is there a secret formula to pick good stocks?

Is There a Secret Formula to Pick Good Stocks?

The only reliable way to make money sustainably in the stock market is to buy low and sell high. For that to work, you need to answer a couple of questions: what does low mean and what stock prices will go up and what does high mean? With tens of thousands of stocks to choose from, you need some way to weed out everything that's not currently on sale and everything that won't go up sufficiently in the future.

If you had infinite time, you could analyze each stock and its underlying business one by one, but who has that time? If only there were a way to analyze every possible stock every day to figure out the best bargain stock of the day.

Can a Computer Pick Good Stocks?

One of the benefits of the Internet is that copious amounts of financial information is available online. (Indeed, that's much of the value of online stock trading; you don't have to pay broker fees to do basic research for you.

Beyond having information available via your computer, you can often find spreadsheets and other programs to analyze stocks for you. That implies something very important: that, given sufficient sources of information about stocks, it's possible to design computer programs to analyze those stocks and suggest good stocks to buy.

Joe Ponzio's F Wall Street tells the story of the Enron corporation. On paper, to a naïve analysis, the company's financial information looked great. It reported bigger and better revenues each year. Yet if you looked at the amount of money pumped into the company every year, it was actually losing increasing billions of dollars every year. It wasn't a money-printing machine. It was a money pit hurtling toward bankruptcy.

Sure, it's easy to see that in retrospect, but if you invested based on a simple formula which only looked at revenue, you'd have been in danger of losing your investment on a bankrupt stock.

What Can't a Formula Do?

A computer can't apply human judgment to factors beyond its understanding. All a computer can do is measure and analyze the data it's told to measure. These are often financial information (cash yield, free cash flow) and derived ratios (P/E ratio, current ratio). For these to mean anything, they have to be reported correctly as well as put in the context of similar companies also reporting their financial information correctly.

Put another way, comparing the international conglomerate of Coca-Cola to a small organic soda company from Canada makes little sense. Even though they're both nominally in the same business (selling soft drinks), they're at different stages in the lifecycle of a business and they have different concerns (rapid growth versus sustainable revenue). Similarly, a young biotechnology company does not necessarily compare to the Canadian soda company even though they have the same number of employees and the same amount of revenue. The amount of competition in the market as well as the nature of customers make the two businesses difficult to compare.

A company may have a good intrinsic value when compared to other companies with similar characteristics, but are those other companies similar enough in the ways that matter most to mean that you absolutely should buy one stock over another?

Even if you could answer that question unequivocally "yes", do you trust that the formula doesn't have a bug in it? That the source of data is completely internally consistent? That the interpretation you're putting on the result of the formula is supported by the formula itself?

What Can a Formula Do?

You might think that this is a strange disclaimer for a site such as Trendshare to explore. After all, the goal of the site are to encourage individual investors to take control of their own portfolios by educating them about how the market works and giving them free tools to help identify good stocks to explore further.

Yet rather than promising that every number on the site is the last word in investment, we've always claimed that the value investing formulas we use to analyze stocks exist to give you information. If you go through the thousands of stocks we track every day, you'll find that most of those stocks aren't objectively on sale. That doesn't mean they're bad stocks—many of them are worth owning—but instead that they're not bargains to buy right now.

In our mind, that's one of the biggest benefits of our analysis here at Trendshare. We can help you rule out most of the stocks right now. Based on your knowledge and interests, we can help you identify a handful of stocks to analyze further, on your own, with all of your human intellect and intuition. When and if those stocks make sense—when you can tell a story about the underlying companies, where they've been and where they're going—then you know enough to decide whether to invest now or ever.

No formula can tell you that.

Is There Any Hope for an Investing Formula?

The best formula for investing is one you already know: buy low, sell high. Buy things you understand, when they make sense. Avoid things you don't understand. By all means, use the tools at your disposal (investment websites, financial information, stock screeners, Trendshare's stock guides) to winnow the field down to a few good candidates for further research. Yet never let adherence to any specific formula override your own judgment. It's your money. It's your investment. Take charge and use your mind most of all.