Investing Tip:

A Good Rule About How to Buy Stocks - The 40/40/20 Rule

Probably the biggest problem people have in deciding to buy a stock is figuring out what's important. There is a mountain of information out there, but what really matters? That's where this rule comes in. Basically it's this:

  • 40% of the decision is based on past financial (*not* stock market) performance.
  • 40% of the decision is the company's current situation.
  • 20% on future expectations.

Many amateur investors run into trouble right here. They base 100% of their decision on future expectations. They hear something on the news, or read an article about the possible positive future and immediately call their broker. The problem is that the future is unknowable and unpredictable, so only 20% of our decision should be based on that. What's more important is a history of good earnings performance (40%) and a good solid foundation right now, both businesswise and financially (40%).

These are of course very subjective measures. But if you sit down and pick a company at random, you'll find you can at least eliminate a number of not very good stocks using this rule.

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Donald Steinmann and Advanced Financial Management assume no responsibility for any actions taken due to comments made in The Investment Tip of The Week.

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"A good decision is based on knowledge and not on numbers."
-- Plato