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How to Pick a Stock: Four Basic Questions for Stock Picking

written by: Trent Lorcher•edited by: Rebecca Scudder•updated: 5/5/2010

"Buy and hold," my broker says, "You're safe. I've got you invested in blue chip companies, Dow components, and industrial giants." Sound familiar? It's time to ditch the broker who's making you broker and become your own broker.

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    The Old Stock Trading Strategy

    I called my broker the other day and got his answering machine:

    Hi, you've reached Bobby Badinvest. I'm not available. If you're calling for Real Estate advice, press 1. If you have a question about your investments, press 2. If you need assistance with your plumbing, press 3. If you want to purchase milk, press 4.

    I hung up. Which of the four was doing my stock picking? I looked at my IRA statement and concluded it was the milkman. I looked at my statement again and realized that neither the milkman, plumber, or broker knew how to pick a stock. I called back, pressed 2, fired him, registered for an online account, and am doing fine on my own.

    Here's how.

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    Stock Trading Strategy Overview

    Stop picking stocks blindly. Stop blindly listening to your broker's stock picking unless he or she has produced. Any stock trading strategy involves risk, so don't abandon the diversified investments rule.

    The success of your investments ultimately relies on the quality of questions you ask. Here are four questions that will help your stock picking:

    1. What product am I investing in?
    2. Who's going to buy it and why would they buy the product from this company as opposed to the competition?
    3. Can the company produce a high quality product and distribute it in the appropriate time frame?
    4. Who's running the company and how motivated are the employees?

    Choosing a company to invest in requires more than watching sensationalized business reports or reading advice from an "expert." It involves understanding potential investments.

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    How To Pick a Stock: Own What You Know

    Before buying a stock, find out what product the company produces. Determine whether the social, political, and economic climate support the product. For example, would it make sense to invest in automobile companies that produce gas guzzling SUVs or would it make more sense to invest in companies that are focused on hybrid and electric vehicles? How about investing in banks with large amounts of bad loans to ingest? Does the political climate promote fossil fuel industries or clean energy sectors?

    Use your own experience as well. In 2007, I was stunned at the number of bad mortgages middle income families held, and even more stunned at the amount of debt they were in. The same lenders kept popping up--Countrywide and Indymac. It was evident the lending industry was headed for a collapse.

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    How to Pick a Stock: Pick Only the Best Companies

    Just because it's a hot industry doesn't mean you're going to make money. Think Beta vs. VHS or its recent equivalent Blue Ray vs. DVDHD. Only invest in companies at the top of the industry. Don't assume, investigate. When Apple came out with its e-book reader, I wanted one, until I looked at it. I didn't like the feel of it and it was too expensive. The Amazon Kindle was much better. Obviously, both companies do more than just produce e-readers, but this example illustrates the importance of actually trying out the product. Call the company you want to invest in. Evaluate their customer service. Read what other people are saying about the products. Pick only the best.

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    How to Pick a Stock: Invest in Leaders

    Find out who is leading the company. Steve Jobs has a track record of success, for example. Bill Gates--even better success, until recently. Chuck Prince--not so good. CEO's have come under fire recently for making so much money. I don't care how much money the CEO makes as long as he makes me money. Do a Google search (speaking of profitable investments). Find out about the people in charge.

    All the major business sites--Yahoo, MSN, CNN, CNBC--have all the information you could want on who runs the company, what the company does, how much the company earned (or lost), or what troubles lie ahead. There's no excuse for not knowing:

    1. In what product am I investing?
    2. Who's going to buy it and why would they buy the product from this company as opposed to the competition?
    3. Can the company produce a high quality product and distribute it in the appropriate time frame?
    4. Who's running the company and how motivated are the employees?