Stock-Picking Tips for Your IRA

Notice that I am not advocating a relaxation of quality standards when evaluating an investment idea. There are plenty of smaller, less-well-known companies that have solid financial structures and good market positions in their industries.

Being a mechanical investor means that you establish criteria that are never violated. These are quantitative requirements that define your universe of potential investments. For example, you will buy only those stocks that sell at a price/earnings ratio below 20, have a dividend yield greater than 1.0% and have positive free cash flow.

While it's easy to be seduced into buying great "stories," having a set of quantitative requirements that make sense based on investment history is the most sensible way to screen your investment universe.

Also, when you purchase a stock, I believe that a set of sell criteria automatically should be put in place. For example, you will sell when the P/E ratio increases to a level higher than the industry median, when quarterly earnings are reported down from last year or when you have held the stock for 12 months.

How can you arrive at a set of quantitative requirements that actually work and are not dependent on someone else's vision of the future? I'm going to recommend a book called What Works On Wall Street by James O'Shaughnessy. When I read this back in the late '90s, I felt like I finally understood where I should be looking to obtain superior investment performance. This is a very statistically oriented book that goes back about 40 years to see how specific investment metrics can be used to achieve superior results.