It is easy to define profitable investing. It simply means finding profitable companies. Defining further profitable companies is also easy, but actually finding such companies is the tricky part of the process.
So, let’s start with the easy part — what defines a profitable company? In our little book of investing — and we are certainly not reinventing the wheel here — a profitable company reports record earnings and often exceeds analysts’ expectations while its analyst ratings change only for the better.
According to recently conducted market studies, investors who abided by this “holy trinity” of investing would have outperformed the market for eight out of every 10 years. Furthermore, if an investor had purchased the top-30 earnings growth stocks listed on the Toronto Stock Exchange in the past two decades, his average annual return would have been almost 16%, in contrast to the 10% average annual return posted by the composite itself.
Why? This is because earnings per share are often the strongest driving force behind a stocks’ market performance. It is perhaps the most analyzed and forecasted number among analysts, and the most-often quoted reason why investors either buy or sell stocks.
Bear in mind, however, that companies expected to enjoy the most increase in earnings may not necessarily be the wisest choice for your portfolio. Why? Well, if a company’s earnings are forecasted to increase the most and they miss the target, the disappointment is going to be that much greater. And you know what disappointed investors like to do the most? Sell, sell, and sell some more!
The next question is, how can you — an independent investor – profit the most from the earnings data? The first thing to do is not to take earnings expectations at their face value; rather dig a little deeper and look at the past track record. A company that regularly managed to meet or exceed its past earnings expectations is more likely to do it in the future as well. Also, check out the stock’s past record with analysts. If you see too many upgrades and downgrades, it only means there could be more volatility involved than your risk tolerance can bear.
While all of this sounds complicated and appears to require complex stock-screening tools, don’t forget that the Internet is a thing of beauty. Resources such as Yahoo! Finance, Reuters.com, TheStreet.com, Marketwatch.com, etc., will provide most of this information after only a few clicks of the mouse.