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Is There a Secret Formula to Pick Good Stocks?

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The only reliable way to make money sustainably in the stock market is to buy low and sell high. That's a truism. The hard work is answering the relevant questions:

When is a stock price low?

What stocks will go up in value?

When should you sell a stock?

With tens of thousands of stocks, ETFs, mutual funds, REITs, and investments to choose from, you need some way to weed out everything that's not currently on sale and everything that won't go up sufficiently in the future.

If you had infinite time, you could analyze each stock and its underlying business one by one, but who has that time? If only there were a way to analyze everything for sale in the market stock every day to find bargain stocks.

Is there a Stock Trading Formula?

Thanks to the Internet, copious financial information is available online. That's much of the value of online stock trading; you don't have to pay broker fees to do basic research for you. All of the data you could want is available for you to search, if you have the time and inclination to find it and think about it.

Beyond having information available via your computer, you can often find spreadsheets and other programs to analyze stocks for you. That implies something very important: that, given sufficient sources of information about stocks, it's possible for computers and formulas and spreadsheets to find good stocks automatically—even secret stocks with great value!

Yet there's a risk.

Joe Ponzio's F Wall Street tells the story of the Enron corporation. On paper, to a naïve analysis, the company's financial information looked great. It reported bigger and better revenues each year. Yet if you looked at the amount of money pumped into the company every year, it was actually losing increasing billions of dollars every year. It wasn't a money-printing machine. It was a money pit crumbling in on itself into bankruptcy.

It's easy to see that in retrospect, but if you invested based on a simple formula which only looked at revenue, you'd have been in danger of losing your investment on a bankrupt stock.

What Can't a Stock-Picking Formula Do?

A computer can't apply human judgment to factors beyond its understanding. All a computer can do is measure and analyze the data it's given. These are often financial information (cash yield, free cash flow) and derived ratios (P/E ratio, current ratio). For these to mean anything, they have to be reported correctly as well as put in the context of similar companies also reporting their financial information correctly.

Comparing the international conglomerate of Coca-Cola to a small organic soda company from Canada makes little sense. Even though they're both nominally in the same business (selling soft drinks), they're at different stages in the lifecycle of a business and they have different concerns (rapid growth versus sustainable revenue). Similarly, a young biotechnology company does not necessarily compare to the Canadian soda company even though they have the same number of employees and the same amount of revenue. The amount of competition in the market as well as the nature of customers make the two businesses difficult to compare.

A company may have a good intrinsic value when compared to other companies with similar characteristics, but are those other companies similar enough in the ways that matter most to mean that you absolutely should buy one stock over another?

Even if you could answer that question unequivocally "yes", do you trust that the formula doesn't have a bug in it? That the source of data is completely internally consistent? That the interpretation you're putting on the result of the formula is supported by the formula itself?

Can You Find Value Stocks Automatically?

This disclaimer may seem strange for a project such as Trendshare, which has a goal to encourage individual investors to take control of their own portfolios by educating them about how the market works and giving them free tools to help identify good stocks to explore further.

Yet rather than promising that every number on the site is the last word in investment, the value investing formulas used to analyze stocks exist to give you information. Most of the stocks evaluated here every day aren't on sale. Many of them are worth owning—many of them are great businesses—but they're not bargain stocks right now.

That's the biggest benefit of automated stock analysis, to help you rule out 99% of the available stocks out there. Based on your knowledge and interests, you can identify a handful of stocks to analyze further, on your own, with all of your human intellect and intuition. When and if those stocks make sense—when you can tell a story about the underlying companies, where they've been and where they're going—then you know enough to decide whether to invest now or ever.

No formula can tell you that.

The best investing strategy is one you already know: buy low, sell high. Buy things you understand, when they make sense. Avoid things you don't understand. By all means, use the tools at your disposal (investment websites, financial information, stock screeners, Trendshare's stock guides) to winnow the field down to a few good candidates for further research. Yet never let adherence to any specific formula override your own judgment. It's your money. It's your investment. Take charge, do your research, and trust yourself.