Setting Goals and Making Plans
Once you realize how much information is available in The
Value Line Investment Survey, the next step is figuring out how you can use it.
Before you begin to invest in stocks, you need to decide
what you want to accomplish.
The first and most important step is to define your
financial goals and determine when you will need the money to meet these goals.
Then you can plan an investment strategy.
Once you have determined your financial goals, you can begin
to create an investment plan for meeting them.
An investment strategy is a plan for selecting financial
vehicles that can help you meet your goals. It involves identifying both the
appropriate types of investments and the most suitable individual investments
within each type.
Developing and sticking to an investment strategy provides
much sounder long-term results than buying stocks or other investments at
random, even if individually they may be smart choices with strong performance
For the purposes of this explanation, there are three basic
styles of investing: conservative, moderate, and aggressive. In brief, a
conservative investor wants to protect principal and earn income; a moderate
investor is willing to take a certain amount of risk to achieve some stock
price appreciation as well as current income; and an aggressive investor is
primarily concerned with high overall returns even though it means taking more
Whichever type of investor you are, you can use the
information Value Line provides as a tool for finding the investments best
suited to your goals and your style.
Smart investors build diversified portfolios.
You create a diversified stock portfolio by buying a variety
of stocks in a range of different industries. For most individual investors, a
practical approach is to own at least 10 stocks in approximately equal dollar
amounts in several diverse industries.
Diversification is important because portfolios with several
different investments usually produce a more consistent and stable total return
than portfolios with just one investment. If you own just one stock and it
drops dramatically in value, the value of your investment portfolio also drops
sharply. But if you own 10 stocks in different industries, the likelihood is
that even if some of them decline in price, others will increase or, at the
very least, remain stable. Decades of investment analysis demonstrate the
validity of the diversification approach.
Although your portfolio might not gain as much as if all
your money were invested in one stock whose price escalated quickly, it is
unlikely to lose as much either. It is important to remember that it is
difficult to predict which individual stock will be a winner.
Remember, too, that you ought to think of a
diversified stock portfolio as one component of an overall diversified
investment strategy which could include bonds, cash, real estate, etc.
All investments involve risk of one kind or another.
The general rule of investing is that risk is linked to
total return, or what you get back in terms of price appreciation and dividends
on your investment. The greater the risk you take, the greater your return
should be. The less risk you take, the less return you should expect.
You can manage the risk of losing money when you invest in
stocks by creating a diversified portfolio of a variety of stocks in a range of
different industries. That allows you to balance potential losses in one stock
against potential gains in another, since certain stocks and certain industries
tend to perform well when others lag and vice versa.
You assess risk as part of making investment
choices. If you are primarily concerned with preserving your principal, you
should build your portfolio around stocks that Value Line ranks 1 or 2 for
Safety. The return based on price appreciation that you can expect on those
stocks may be lower than the return you could expect from stocks with lower
Safety ranks. On the other hand, you can be fairly confident that those stocks
will be more price-stable than the broader market during a period of falling
prices, even though there is no guarantee that, in a market slide, these stocks
won't also decline in value.
You might hear a stock described as overvalued or
undervalued. That's generally a comment on how much investors are currently
paying for the stock in relation to the valuations of other stocks.
An overvalued stock is often one whose P/E ratio is high
relative to the rate at which a company's earnings are likely to grow. In some
cases, the future performance of these stocks may not be able to sustain the
high expectations implicit in the price investors are paying. However,
overvalued stocks often get positive press coverage, which builds enthusiasm
for the stock and elevates the price even more, at least for a time. In a
downturn, the price typically falls until the stock's P/E is more in line with
the median P/E of the approximately 1,700 stocks in the Value Line universe.
In contrast, an undervalued stock is selling at
a P/E that is modest relative to other stocks in the Value Line universe, investors
can reap the benefit of strong future performance. Assuming that enough
investor attention shifts to a stock’s merits and demand for the stock
increases, so too will the price.
Book value is the amount that would be left for common
shareholders if all the tangible and intangible assets of a company could be liquidated
and all the long and short-term debt, taxes, and preferred shareholders were
paid. Tangible assets include the physical plant, inventories and money the
company is owed, while intangible assets are the value of patents or brand
names (often known as "goodwill").
Value Line calculates the book value per share
for every company, and also indicates in a footnote how much of a company's
book value is based on intangibles. Conservative investors may want to deduct
these amounts when they are analyzing the financial strength of a company.
Dividends are the part of its annual profits that a company
pays to its stockholders as income. That percentage is called the stock's
payout ratio. Well-established companies are more likely to pay higher dividends
than smaller or growth-oriented companies that often prefer to use their
profits to fund additional expansion.
A per share dividend as a percentage of a stock's current
price is the "yield" to the investor. Investors seeking income will
typically look for stocks with above average dividend yields.
One consequence of earning dividends is that
they are taxable, whereas price appreciation of a stock is not taxed until the
stock is sold.
Next in Value Line University: Building a Portfolio