Knowledge is power on Wall Street, and investing pros have the reputation of being the most knowledgeable. But if you’re not a pro? Well, individual investors can still take advantage of many of the pros’ top techniques and turn some of their own knowledge into real investing success.
Individual investors have many advantages over the big institutional investors — especially the ability to invest with a long-term mentality and to buy out-of-the-way hidden gems. But they can also leverage information to identify some potentially highflying stocks, too.
Here are a few of the best ways for individual investors to research stocks and get a leg up on their professional counterparts, as well as one way they can keep more of those gains.
What the pros do
Here are five techniques that pros use to figure out what’s really going on in the market. Often these methods require a little more hustle than just reading the numbers on a screen or balance sheet, but you can also find out more that way than you could otherwise.
1. Use a stock screener
A stock screener is a great place to begin for investors on the hunt for new ideas. With a good stock screener, you can find stocks that are hitting 52-week lows, if you’re a value investor, or new highs, if you’re looking for momentum stocks that could continue their trend.
This information can be paired with other financial details that are available in the screener, such as a company’s revenue growth, profit margins, debt and many more. You’ll want to look for a high-quality screener the provides highly granular — and fully up-to-date — information.
Stock screeners can be found at some of the top brokers, but you may want to hunt around for one that fits your exact needs and process best.
2. Talk to management teams
It may seem like the management teams are off-limits to individual investors, but not always. Sure, Facebook CEO Mark Zuckerberg is not likely to take your call, but you have a real chance to ask questions at smaller firms, where execs will speak with current or future investors.
You’ll want to have pertinent questions lined up that show you know the business, and it can be a moment to ask insiders the finer points about the business. Even if you can’t get on the phone with the top brass, you can access a public company’s investor relations department. IR, as it’s known, can provide financial details or perspective on a news release, among other things.
It can also be helpful to ask a management team which other companies they respect most in the industry and why. This line of questioning can give a good perspective on which rivals are worth watching — and they may even be worth investing in, too.
3. Do your own firsthand research
Getting out from behind the desk can be a great way to find out what’s actually going on before it breaks big. That’s classic advice from investing legend Peter Lynch, who recommends watching for new trends emerging with friends, whether it’s a new product or service.
Have you heard about a great new restaurant in the area? Check it out and see what you like and whether its operation is running smoothly. A neighbor likes a new tech gadget? See for yourself what it’s all about — and then assess if the company is worth an investment.
This way is great for finding a hot new consumer brand, especially in the restaurant or retail spaces. Food fans could easily have picked up future high-flyers such as Chipotle and Panera before they became big household names. Even if investors didn’t get in at the bottom, these restaurants had years of attractive growth remaining in them after they were “discovered.”
4. Run your own channel checks
Especially for consumer or retail brands, you can do some of what Wall Street analysts call “channel checks.” A channel check is a fancy name for actually seeing what amount of product is moving through the system. A channel check can give valuable information about what’s happening now before it shows up in the reported financial statements in three or six months.
For the pros, a channel check might involve calling up suppliers and customers of a target investment and seeing how much business the company is doing. In the case of individual investors you can do much of the same with consumer brands, asking questions such as:
— Is that new product getting shelf space at your local grocery store?
— Is the product getting more space over time or less?
— Is the parking lot at that hot new chain restaurant or retail shop getting even more crowded?
— Or maybe the restaurant is getting less crowded or getting poor reviews?
You can run your own channel checks and see trends that might not show up in the results yet.
5. Subscribe to a newsletter
An investing newsletter is a great resource for individual investors, and it’s a technique that pro investors use as well, though the two kinds of newsletters typically focus on much different analysis. Still, a good newsletter can help individual investors find and evaluate good investment opportunities, and give them a wider perspective, since the market is so large.
It may seem like Wall Street investors are omniscient, but they outsource a lot of research to third parties. That’s exactly what individuals can do, but they may have an additional advantage, because they can invest in small, high-growth businesses that the big investors can’t touch. Plus, you may have the added advantage of bouncing good stock ideas off the newsletter pros.
Look for a reputable newsletter company with a long track record and a history of treating subscribers well. In some cases you can find good newsletters for a few hundred dollars a year.
How to really let your money compound
While Wall Street has a reputation for being knowledgeable, success is not all about having the most info. The best investors really know how to minimize taxes and keep more of their money. So you’ve researched and found a great stock — here’s how to keep your gains compounding.
You may have found an undervalued stock that should go up to fair value and then you’ll sell. Or you may hunt for compounders, stocks that can grow for years, even decades. Think of PayPal, Amazon, or Starbucks, for example. It’s a classic dilemma between growth and value investing.
But whether you’re a value or growth investor, it’s important to realize that if you sell a winning investment in a taxable account, you’ll be liable for taxable gains (at either the short- or long-term rates). So every time you sell a winning investment, your wealth is going to be reduced by the taxman’s cut.
Instead, by not selling, you’ll defer any taxes, meaning that the wealth remains yours. But not only do you avoid the taxes, you’ll be able to compound on the full pretax amount each year.
For example, imagine you invested $10,000 and gained 20% annually but sold right at the end of the year, incurring a tax rate of 20%. In five years you’d turn $10,000 into $21,000, and average about 16% annualized gains, since the government took its cut each year.
But what if you held your stock during that whole period? You’d compound the whole amount at 20% annually, turning $10,000 into just over $24,883. Even if you decided to sell at that point, you’d still realize an after-tax amount of about $21,906 — more than in the first scenario.
The difference? You’ve compounded further gains on top of the gains you had to pay taxes on in the first scenario. In effect, by not selling your stock, you’re forcing the government to defer its taxes and to give you the ability to keep compounding on the full, pretax amount.
That’s how legendary investors compound their gains when it makes sense. It’s not just a question of having the best research but also using it the best, in this case by minimizing taxes.
While it’s easy to lament that Wall Street pros have huge advantages over individual investors, even the little guys have ways to use some of the pros’ techniques. And in some cases, individual investors even have advantages that large investors can never take advantage of.