There are Rules!

The best book I have read so far to prime me for the stock market has been How to Make Money in Stocks by William J. O'Neil.  His rules for evaluating and for buying stocks can be best summed as:

1. Look at current quarterly earnings per share.  Quarterly EPS must be up at least 18% or 20%, but preferably up 40% to 100% or 200%....or more!  The higher, the better.  EPS should also be accelerating in recent quarters.  Additionally, quarterly sales (i.e. revenue) should also be accelerating or up 25%
2. Annual earnings increases.  There must be significant (look for 25% or more) growth in each of the last three years and a ROE of 17% or more; 25% to 50% preferred.  If ROE is too low, pre-tax profit margin must be strong.
3. "NEW!"  New products, new management, new highs!  Search for companies with new products and/or services, new management, and/or significant new changes in industry conditions.  Try to buy stock as the companies emerge from sound, properly formed chart bases and being to make new highs in price.
4. Supply and demand - shares outstanding plus big volume demand.  Any size capitalization is acceptable in today's new economy as long as a company meets all criteria; i.e. EPS requirement, sales requirement, etc.
5. Buy market leaders!  Draft the all-stars!  No one would draft Ryan Tannenhill when they can have Andrew Luck!  Always look for the number one company in its field or space.  
6. Buy stocks with increasing institutional sponsorship and at least one or two mutual fund owners with top-notch recent performance records.  Also, look for companies with management ownership.
7. Understand the market direction by analyzing the daily market indexes' price and volume movements and the action of individual market leaders.  This can help determine whether you win big or lose big.  One needs to stay in gear with the market.  It doesn't pay to be out of phase with the market.

Rookies and IPOs

Every year in fantasy football, teams go out on a limb and draft rookies who have the potential to have a big impact on their team.  In 2014, Carlos Hyde, Bishop Sankey, Brandin Cooks, Devonta Freeman, and Mike Evans were all rookies that were drafted in virtually all fantasy football drafts.  However, it's quite likely, none of these players were drafted before the fifth round.  What does this mean?  It means most fantasy teams formed a foundation for their teams with solid, proven players before they took the risk of adding an unproven rookie to their roster, no matter what their potential was.  Why?  Because they could be busts, they might not see the field (many rookies play behind veterans), or their playing time could be limited (for a myriad of reasons).  However, many teams still draft these rookies and put them on their bench until it is better known how they will be utilized and what their effect will be across the greater team.

This same approach can be taken with IPOs.  However, instead of adding these rookie companies immediately to your portfolio, wait and see how the companies will perform.  That is, keep them on the bench before you include them in your starting lineup.  The products and services these companies offer may not be well received in the market place.  Or, their competition may respond in such a way that may put the rookie company in dire straits.

This is not to say ignore IPOs and never add them to your portfolio.  It is to say, let them prove their worth first.  Make sure they demonstrate big gains in sales and earnings per share.  While it might seem you are missing out on huge gains by not buying stock immediately, those "gains" pale in comparison to the potential losses for buying stock in a company that will fail.  Good, strong companies will continue to grow in great strides beyond their first six months since issuing stock.  Case in point, GOOG went public in August 2004.  In its first six months, it grew 72%.  While this might seem like a huge missed opportunity, GOOG grew by another 43% in their second six months, which is still huge.

BNNY went public in April 2012 and went up 29% in its first six months, then preceded to fall 15% in their second six months.  BNNY's next big performance spike didn't come until September 2014, when it was bought by GIS.

Remember, the stock market is a fantasy football league of one and the objective is to grow your portfolio over a long period of time.  Not just in short spurts.  You can pick any stock to put in your portfolio, why not put the best stocks in your portfolio?  And when another company is showing better, more consistent performance than one in your portfolio, that's the time to make a substitution.

I want to revisit this analogy later when I have time to research it, but I want to compare rookies drafted in fantasy football versus IPOs.  I have a feeling there are many similarities between rookie who make NFL careers or bust versus IPOs that perform well over several years or just sputter and fade.

Preparing for Battle

My first year in fantasy football, I was awful.  For the draft, I didn't research players and I didn't have a complete understanding of the point structure.  I just wanted to have fun with some friends, and I didn't think a $50 entry was much to lose (or gain).  So, I picked players that I knew regardless of how they ranked or stacked up against their peers.  Yahoo auto-picked a few players because I was slow to decide.  It wasn't until after the draft that I realized I showed up to a gun fight with a knife.  My team was horrible.  I was ridiculed, rightfully so, by the other owners in my league.  However, as painful as the experience was to commonly be referred to as the "doormat of the league", I really learned a lot that first season.

I began studying the players' stats over the course of the season looking for drop-off points in the performance level and trying to identify the "elite" players, the "serviceable" players, and "if this guy is on my team than I've done a lot of things wrong" players.  Around draft time, I would look at numbers from the prior two seasons, breaking the players out into their respective positions.  Essentially, I was taking the emotion out of my decision making of who was going to draft and not going to draft, and I was going to pick teams based on performance.  Nothing else.

I wanted to do the same with stocks.  However, I didn't know what to look for.  As a lifelong fan of football, I know what the game's stats mean.  I know what stats say if a player has had a good game or a bad game.  A good season or a bad season.  Whether they are getting better or getting worse.  But, I didn't know how to do that with stocks.  So, I decided to study first.  I picked three books to read:

• How to Make Money in Stocks by William J. O'Neil
• The Intelligent Investor by Benjamin Graham
• The Complete Idiot's Guide to Stock Investing by Sarah Fisher and Susan Shelly

The first book, How to Make Money in Stocks, was mind-blowing to me.  O'Neil provides amazing explanations on numbers using historical examples.  And, for me, perhaps most importantly, it was while reading his book that I saw how analogous the stock market is to fantasy football.  I love statistics and trends; I use them as the foundation to pick a fantasy football team.  And here, in this book, O'Neil talks about what metrics (i.e. stats) to look for in a stock (i.e. player), how if the market (i.e. season/career) is moving a certain way you can tell if it's time to sell (i.e. drop) or buy (i.e. claim off of waivers), how it's important to diversify your portfolio (i.e. roster) by having stocks (again, players) from different sectors (i.e. positions/teams).

Using the collected learnings from these three books, I created my own strategy.  One so that I wasn't picking "home team" companies, but rather picking companies that performed.  Also, and perhaps most importantly, just like in fantasy football, I had to include protective measures to allow me to break away from companies that aren't performing.  In fantasy football, you don't want to start an under-performing player week after week and you don't want to get caught starting a player on a bye.  The same is true in stocks.  It's important to know when to cut your losses and to drop that player/company and find a new one to add to your roster/portfolio.

Getting Started

You can choose to invest in the stock market the same way one would play the lottery, in that you buy a stock in a company because you like their name, where they're located, or think their ticker letters are lucky.  Or, you can choose to invest in the stock market as you would if you could build the ultimate fantasy football in you were in a league by yourself.  If you were in a fantasy football league by yourself, you would have the best QB, the best RBs, the best WRs, the best TE, the best K, and the best D.  It's easy to identify who the best players are in fantasy football because over the course of the season, the best players rise to the top.  How are they identified?  They generally are leaders in yards (i.e. passing, rushing) and touchdowns and usually have very low turnover statistics.

The same is true with stocks.  Stocks, like fantasy football players, can be valued based on a company's performance.  It's just a matter of knowing which metrics to identify and which companies have the best metrics.

Yes, this is generalizing the stock market by a lot!  Yes, there is a lot more that is involved!  But with every strategy, there needs to be a foundation.  And the foundation for this strategy, is to take the same strategy I employ for fantasy football, and implement it into buying stocks.

Let's get started....