I vividly remember the first stock I ever bought. It was Peoplexpress, the pioneering no-frills airline. I got the idea from a very convincing article in Forbes magazine. Perused the company's annual report. Got an analyst's research report on the stock from a roommate who worked on Wall Street. Even tried a couple of its flights and choked down some of the airline's infamous peanuts before I bought.
Yep, I did just about everything the conventional wisdom tells you to do before buying a stock. And I still lost all $400 I had invested when the company went bankrupt a year later.
I think I can do better than that today. Buying your first stock boils down to three steps that I call "Show me the money," "Tell me a story" and "Find a friend." Let me pick a stock that I'd buy now --
-- to illustrate how the process works.
But first, some small print. Yes, I do know investing isn't quite this simple. What about checking to see that the stock complements the other assets -- like a house -- that you own? What about factoring in how long you'll hold the shares? Or risk? Those are all important, but we're talking about buying a first stock, the initial step in a long process of learning and investing. Worry about the big picture later, when you've got more than a few dollars in the market and own shares in five companies. Right now, I want you to get your feet wet in a way that will teach you something about how to pick a good stock.
Step 1: Show me the money
In some ways, I understood Peoplexpress very well. It was an airline that, by eliminating frills like meals and reservation systems, flew passengers for prices that radically undercut the competition. But I didn't understand Peoplexpress in the most important way -- I didn't understand what had to happen so that the company could make a profit.
Now, let's use
to get a handle on Washington Mutual's business. In the Investor's Stock section, check out the
Company Report -- it describes what the company does. These sections tell you that Washington Mutual is the largest thrift (another name for a savings and loan) in the country. Actually, Washington Mutual isn't just large -- it's huge. Thanks to acquisitions of other thrifts such as
, the company does business in 40 states and is one of the dominant financial institutions on the West Coast. The company is also a truly national player in key product lines. By buying the mortgage operations of
Bank United of Texas
, for example, Washington Mutual has become the second-largest residential mortgage lender in the U.S.
To go deeper, click on the
SEC Filings link and read the company's most recent annual report -- called a 10-K. Look most closely at a section called Management Discussion for details on how the business operates. Finally, go to
Key Ratios in the Financial Results area. The tables of
management efficiency and
investment returns will tell you how the company measures up against similar companies such as
Golden West Financial
, and against the stock market in general. The numbers clearly show that Washington Mutual is significantly more profitable than the average big company. As I write this, for example, the net after-tax profit margin at Washington Mutual is 12.2%, compared with 7.3% at the average company in
Standard & Poor's 500
index. And Washington Mutual is more profitable than the average savings and loan, as well.
Step 2: Tell me a story
OK, why should this or any stock that you want to buy go up? Do you think the stock is cheap and will go up when other investors discover that it's underpriced? Or maybe you want to argue that profits are about to spurt -- a kind of story called growth investing. Fair enough, but is either tale convincing?
Price Ratios table in the Financial Results area will give you an idea of how overvalued or undervalued a company's stock is compared to other stocks. Those numbers tell you that Washington Mutual is more than 40% cheaper than the market -- the company trades at a
price-to-earnings ratio of 16 when the average stock sells for 26.6 times earnings per share. On this page, you can also see that Washington Mutual has traded for a much higher price-to-earnings ratio in the past, as high as 56.7. It's up to you to decide if the company's much-better-than-average profitability and future prospects might make investors willing to pay more for the stock in the future than today's 14.7 times earnings per share.
Earnings Estimates in the Analyst Info area let me know that Wall Street thinks the company's future over the next year is full of potential. Earnings are projected to grow at 18% in calendar 2001, up from just 7% this year. That's well above the 9% earnings per share growth analysts are projecting for the stocks in the S&P 500.
Where's the growth going to come from? You can find out what Washington Mutual thinks by following the link on the Company Report page to the company's
Web site. In the Current News Releases section of the About Us part of the site, you'll find the company's Oct. 17 press release announcing its quarterly earnings.
There, Washington Mutual notes that it added a record 141,000 new retail-checking accounts in the quarter and increased the number of residential loan originations by 12% and the number of other loan originations by 59%. Depositor and other retail banking fee income grew 29% from the same period a year earlier. Clearly, the company's growth strategy of aggressively but efficiently adding new households to its customer base and then cross-selling them multiple financial products is working.
Step 3: Find a friend
There's no point in buying a stock that you can't get along with. Sooner or later, the incompatibility is going to make you do something you'll regret. For example, if your stomach ties itself in knots just thinking about the prospect of a stock you own dropping 10% or 20% in value, you probably shouldn't make a volatile Internet stock your first choice. Odds are, you'll give in to the pain and sell it just when you ought to hold on through a short-term problem.
To see if you and a stock are a good match, check out a
three-year historical chart. Is it full of peaks and troughs or relatively smooth? Two other numbers also help characterize a stock.
Beta measures how volatile a stock is in relation to the market as a whole. A stock with a beta of 1 matches the market; a stock with a beta of 1.1 moves up and down about 10% faster than the market. A stock with a beta below 1 moves less rapidly than the market as a whole. On
, you'll find a stock's beta in the
Company Report section.
Following the Research Wizard, you'll also find another useful number called Relative Strength on the Company Report page. This tells you how well this stock has appreciated relative to the market as a whole. The higher the number, the better -- a stock with a relative strength of 75, for example, has outperformed 75% of the market for the period.
Looking at these data on Washington Mutual, I see a very stable stock -- beta is just 0.9. The chart shows that the stock can go down -- as it did at the beginning of 2000 and at the end of 1998 -- but that the trend has been steadily upward since spring of 2000. The stock's current relative strength of 98 (up from 97 for the past six months and 95 for the past 12 months) tells me that the stock is headed in the right direction. All in all, a pretty good psychological match for most beginning investors.
Washington Mutual may or may not be the stock for you. I use it here only as an example of some of the things to look for.
But of something else I feel sure: These three steps -- "Show me the money," "Tell me a story" and "Find a friend" -- will help you buy your first stock and a good many after that. As you learn more about investing, you can build on this foundation, make it stronger, add extra stones and slather on more cement. But you won't ever need to abandon it.
At the time of publication, Jim Jubak did not own or control shares in the equities mentioned in this column.
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