TeenBusiness.com > Teenvestors > Stocks > Selecting Stocks


There are probably over 10,000 stocks you can buy for your investment portfolio. There is no way you can investigate each one of these stocks to see which ones are likely to increase in value. Our general investment advice to Teenvestors is that they should invest in what they know and in products in which they have an interest -- at least at the beginning of their life-long investment efforts. The important thing is to get started buying the stocks of strong companies that will be around for the next 20 or 30 years.

It is important that you make a habit of investing in stocks on a periodic basis. Once a month, two times a year -- it doesn't matter as long as you make it a priority to put your money in assets that are likely to grow. We have a few suggestions that can help you decide what stocks to buy.

Stick With Big Companies (Initially) 

Buying the stock of big companies is the best way to start investing in stocks. Size is an important way investors classify companies is by size. The size of a company is important to investors because big companies are generally considered less risky (i.e. safer investments) than tiny companies. This is because, as a rule of thumb, the value of the stock of a big company does not move up and down as quickly as the value of the stock of a small company. In addition, the profits of big companies generally don’t grow or shrink as fast as the profits of small companies. Investors measure the size of a company by its Market Capitalization or Market Cap as it is commonly known.

Market Cap

Market cap is the number of a company's shares held by the public times the current stock price. Mathematically, it is represented as follows

Market Capitalization = (# of Shares) x (Current Stock Price)

As you can see from the above formula, the market cap of a company changes as its stock price changes. Our five sample companies had the following market capitalizations:

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Market Cap Classification

Investors typically use the terms large-cap, mid-cap, small-cap, and micro-cap, to classify the size of companies. There are no clear-cut numbers for determining whether to classify a company as a large-cap, mid-cap, small-cap, or micro-cap company. Our research, however, shows the most common classification as follows:

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We recommend that beginning Teenvestors start with large-cap companies because the stock prices of these companies don't go up or down as much as the stock prices of smaller companies. The general rule is that the bigger a company is, the less the stock price will move up or down. The Dow consists only of large-cap stocks, which generally have stable prices over a short period of time. But of course, stable prices also mean that the stocks in The Dow don't appreciate quickly either. Over a long period of time, however, large cap shares do well. Large-cap Dow companies like Coca-Cola and General Motors have made some people mighty rich.

After getting your feet wet with large-cap companies, you can also try companies in the higher range of the mid-cap classification (i.e. market cap of $5 billion and above). We recommend that you stay away from small-caps until you're really good at doing company research (which might be three or four years from now).

Staying Clear from Micro-cap Stocks

Under no circumstances should you invest in micro-cap stocks (also known as penny stocks). Some beginning investors find penny stocks attractive because they can be bought for a few dollars per share, or even for pennies per share. But these stocks are extremely risky; it is difficult to get reliable information about the companies that issue them or information that can tell the investor whether the stocks are good investments or not. In fact, these types of stocks are open to fraud by brokers for reasons we can't explore here. To put it plainly, there is a good chance you will lose your money with penny stocks unless you really know what you are doing and you have a reliable source of legitimate company information.

Diversification

You have probably heard of the old saying, "don't put all your eggs in one basket." When choosing stocks, investors try to invest in a few different companies so that no one stock that loses its value can affect their whole portfolio (the basket of stocks and other investments). The act of investing in several different types of stocks to achieve this goal is called diversification.

Investors diversify their portfolios because when a stock goes down or rises in value, other stocks in the same industry tend to go down or rise in value as well. This means that if General Motors stock goes down, the stock of Chrysler is also likely to be lower because the two companies are both in the automobile industry. In order to protect the value of their portfolios, investors diversify by buying the stocks of companies in different industries so as to reduce the chance that the entire portfolio will lose too much value if one industry has a problem. So, for example, an investor might include the following stocks in a portfolio: General Motors (car industry), IBM (computer industry), and McDonald's (food industry). Because these stocks are all in different industries, it is unlikely that a problem in one company will affect the other two companies.

Teenvestors find it hard to diversify because they have very little money to invest with. Nevertheless, it is important to know the value of not putting all your eggs in one basket if you ever get enough cash to spread your investment around to different stocks. If you are forced to invest in just one or two stocks, you then have to make sure that the stocks are as safe as possible.

Industries Associated With Your General Interests

One way to determine which companies are worth investing in is to identify anindustry category that interests you. An industry category defines the line of business a company is in. For example, Walt Disney is in the entertainment industry while Dell Computers is in the computer industry. This technique is useful if, through your research and reading of business publications, you determine that a particular industry will be a good investment but you don't know exactly which companies in that industry will make for the best investment.

Knowing the industry of the company in which you want to invest also makes it easier for you to compare how the company is doing relative to other companies in the same line of business. Comparing the performance of companies in the same line of business helps Teenvestors determine the great companies in which to invest. The list at the bottom of this page low shows an example of the industry categories used by investors. This list was created by Multex Investor, which runs one of our favorite research websites, www.multexinvestor.com. Many other organizations such as Standar & Poor's and Moody's, have their own industry categories although the major categories from one company to another are similar. Please see Research Resources for other major websites that classifies industries.

Industries Associated With Your Hobbies

Hobbies are often a good place to start when looking for investment opportunities. If your hobby is collectibles, for example, you may be interested in learning more about companies that specialize in sports, art, and other collectibles for hobbyists. There probably isn't one hobby you can think of that you can't find a stock associated with it in one way or another. If you like in-line skating, you can find a company that makes the equipment, the pads, and other items that go along with the sport. If you like basketball, there are some publicly traded companies such as The Boston Celtics or The New York Knicks.

To recap, our philosophy is that when you first begin investing, follow your interests. When you become an experienced Teenvestor, you can then move on to investments that look promising -- whether you have a passion for those businesses or not.

Industry Categories

Industry Categories

The Business In Which Your Relatives Work

Unless your parents work for the government, you can get good investment ideas by learning about the company and the industry they work in to see if there are good investment opportunities there. You will find that your parents have some insight about the industries in which they work. They can tell you whether there are innovative things their companies are doing that will make for attractive investments. For example, we bought a car from a dealer through the Internet by using an online company called Autobytel. The salesperson at the dealership where we picked up the car told us that he was getting more and more car orders through the Internet. As it turned out, shortly after our purchase, Autobytel went public (that is, it started selling stock to the public). Had the salesperson been someone we know on a social basis, he may have been able to alert us to the trends in his industry regarding online auto sales. We would have been on the lookout for companies like Autobytel that enable consumers to shop for cars online. Not that we would have purchased the company's stock, but we would have at least paid more attention to the profitability of Internet automobile transactions.

Ask your parents to bring back any company annual reports or brochures the company produces for the public. Your parents can give you some insight on the trends in the industry, the competitors, and the general feelings of the employees in the company. Keep in mind, however, that depending on your parents' positions in their companies, there may be a limit to the amount of information they are allowed to pass on to you. This is because senior managers at companies can't benefit from certain information they know about their companies (called insider information ) unless the information has been released to the general public.

Don't just stop with your parents. Your other relatives and neighbors have a wealth of knowledge you can tap to learn about what is going on in different industries. They can alert you to trends before everyone else knows about them. Make a habit of asking about the businesses they are in and about any exciting products or services their companies are developing. Once again, you can ask these relatives for annual reports and other publicly available information that may help you understand the industry in which they work.

Speaking of friends and relatives, you should do your own research before making any purchases. Some people have a habit of boasting about their great investments without mentioning their losses in the market. There are no sure things when it comes to investing in the stock market.

Look To Your Friends and Classmates for Ideas

Other young people are excellent sources of good investment ideas. Just by observation of what your friends and classmates love to wear and eat, you can see some good investment potential. The entertainment they choose can also be a clue to the right stocks.

For example, if you notice that your classmates prefer Powerade instead of Gatorade, perhaps this is a sign that you should look at investing in Sportade. Look around your school for items that are popular among your classmates. Look around your house for products, foods, and gadgets that your family prefers. Ideas are everywhere. Don't limit yourself to just what is in your immediate environment. The only thing to watch out for is that you should probably stay away from items that appear to be fads and so will probably fade away in a year or two.

Start Reading Business Publications

Teenvestors should read business magazines and newspapers available in the market. Fortunately, 13- year olds can read and understand most general business publications. We even know an 11-year old who reads The Wall Street Journal on a regular basis.

In our opinion, The Wall Street Journal should be required reading for every Teenvestor. Find a copy and, at the very least, just stare at the front page -- you are sure to absorb something from this great publication. In addition, high-quality business magazines such as Forbes Fortune , and Business Week sometimes do long articles on big companies. These publications can often save Teenvestors lots of time because they publish detailed up-to-date articles on some of the biggest companies in the United States. The important business magazines can be found in most libraries, in newspaper stands and on the Internet.

There are also some relatively new magazines such as Business 2.0 (one of our personal favorites), Industry Standard , and Fast Company , which write about technology companies. Although we feel that high technology investing is for the advanced Teenvestor, you may want to sample some of these magazines as well.

Here is a list of the magazines that will help you become a true Teenvestor:

The Wall Street Journal
Investor's Business Daily
Business Week
Fortune
Forbes
Business 2.0
Fast Company
Industry Standard
Individual Investor
Money
Kiplinger's
Smart Money

If your parents have a subscription to The Wall Street Journal , you can get an online version of the paper at a discounted rate.

Look At The Companies Headquartered In Your State 

If you look around, you will notice that there are some big companies with headquarters in your state. This is probably no surprise to you if you live in the eastern states such as New York, New Jersey or Massachusetts. But states with smaller populations also have sizeable corporations. Because these companies are in your state (or in some cases, in your city), you may be able to get information from them more quickly. In addition, your family may even know people who work for them who can help you in deciding whether they are good candidates for your investment dollar. The annual Fortune 500 edition of Fortune magazine usually lists the biggest companies in the U.S. by geographical areas. Look for a copy in your local library or purchase one from your local newsstand.

What To Avoid

Chat Rooms Ideas 

There are lots of online chat groups that discuss investments. Some people probably get good investment ideas from these chat groups but you should know that some of the chatters have been known to be individuals who work for (or manage) companies they are chatting about. In addition, any fool with fingers can type advice into a chat room which hundreds of thousands of people read. We recommend that you stay away from online investment ideas being given by people whom you don't know.

If you need more reasons not to chat your way into investing, how about two words:insider trading . Insider trading is when you use important information that is not public (that is, the company has not released the information to the general public) to make money. In 2000, the U.S. government, for the first time, charged a bunch of people who met each other in a chat room, with sharing insider information on the Internet. One man passed information to another, and another, and it mushroomed from there. Everyone who got information and bought stock based on that information, whether the information was from the initial source or not, was held responsible by the government.

The items described below are things you should look out for when considering making any investments. If you stay within these guidelines, you will be less likely to be scammed by shady characters.

Avoid Companies You Don't Know

If you’ve never heard of a company, broker, or advisor, spend some time checking them out before you make your investment. Most public companies make electronic filings with the Securities and Exchange Commission (SEC – www.sec.gov) and there are computer databases for researching brokers and advisers. Your state securities regulator may have additional information. Incidentally, if a supposedly upright financial firm only lists a post office box as an address, you’ll want to do a lot of work before sending your money. And if anyone mentions the words “Penny Stocks” or mentions stocks that trade in the $1 range or less, run away as fast as you can.

Avoid Investments You Don't Understand 

Con artists frequently use a lot of big words and technical-sounding phrases to impress you. But have faith in yourself! If you don’t understand an investment, don’t buy it. If a salesman isn’t able to explain a concept clearly enough for you to understand, it isn’t your fault. Don’t make it your problem by investing in the product. Lest you think that fraud only happens to beginning or inexperienced investors, Wall Street experts have also been victims, as evidenced by the WorldCom and Enron bankruptcies – the largest two bankruptcies in U.S. history.

Avoid Investments That Sound Too Good To Be True 

If it sounds too good to be true, it is. Mom was right! Compare promised returns or interest rates with returns on a well-known stock index such as The Dow Jones Industrial Average, and a bond benchmark such as U.S. Savings Bonds – both of which you will learn about in subsequent chapters. Any investment that promises you substantially more than these readily available indexes are, by definition, risky. Risk is not necessarily a bad thing because with more risk, there is the potential that you can make more money. However, you should know how risky something is before investing in it.

Avoid So-Called “Guaranteed Returns”

Every investment carries some degree of risk. As we previously discussed, low risk generally means low returns, and high returns typically involve high risk. If your money is perfectly safe, you’ll most likely get a low return. High risks represent the potential for high rewards for those investors willing to take big risks. Most fraudsters spend a lot of time trying to convince investors that their investments offer extremely high returns, which are “guaranteed.”