How to Invest

in Stocks
How Stocks Work, How to Calculate Return
on Investment and Other Investing Basics
By Timothy Lutts, CEO and Chief Investment Strategist, Cabot Wealth Network
Investing in the stock market can be intimidating. Unless you majored in finance or are in the
investment industry yourself, you may not feel confident enough to invest on your own. So you leave
your annual contribution in the mutual funds you selected so many years ago or hand your account
over to a professional financial advisor.

It’s certainly understandable—at least you’re saving, right? But there are much better options available
than set-it-and-forget-it or hiring a high-priced financial advisor.

You can invest on your own. It’s not as difficult as it sounds. Before you begin investing, it’s important
to understand what a stock is: a stock is an equity investment that represents part ownership in a
company. When you invest in a stock, you own a share (or shares) of that company.

When investing on your own, the most common way to buy a stock is through a brokerage firm. Thanks
to the internet, using a brokerage firm to invest is easier—and more affordable—than ever. There are a
variety of popular online discount brokerage firms—TD Ameritrade, E*Trade, Fidelity— and none of
them charge more than $10 every time you make a trade.

Now, you can choose to invest in just one or two stocks; that’s all some people can afford, and that’s
fine. But for those who can afford it, an ideal portfolio consists of about eight to 12 stocks from a variety
of industries (technology, banks, housing, retail, energy, etc.). It also makes sense to invest in different
types of stocks—growth stocks, value stocks, dividend-paying stocks, emerging market stocks. More on
the different types of stocks later.

However you spread out your investments, the goal is to put together a portfolio that’s diversified
enough that you aren’t overly susceptible to a collapse in any one industry. For instance, if you have all
housing stocks and the real estate market suddenly collapses like it did during the subprime mortgage
crisis … you could lose all the money you’ve invested very quickly.

How to Calculate Return on Investment

Before we get into more investing tips, it’s important to know how to calculate your return on
investment. It’s simple really: your return is the percent that your investments have gone up.

Let’s say you bought 10 shares of Apple (AAPL) seven years ago, when it was trading at $50 per share
(for a total of $500). Today, Apple’s stock price has risen to $227 per share, giving you a total return of
354%. Thus, the $500 you invested in Apple has turned into $2,270!

If you own eight, 10 or 12 stocks, calculating your return on investment can be a bit more arduous.
Fortunately, your online brokerage account does the calculating for you. These days, all you need
to do is log in to your brokerage account, and it will show you the total return (or loss) on all your
investments in real time.

Of course, you can also track the prices of all your stocks during a trading day (Mondays through
Fridays, from 9:30 a.m. to 4 p.m. ET) by looking up their ticker symbols on either Yahoo! Finance or
Google Finance. It will give you up-to-the-minute prices on any stock, no matter how small or obscure.

Now that you know how to invest in stocks, and how to calculate your return on investment, let’s talk
about ways to invest successfully.

First, let’s review some of the different types of stocks you should most concern yourself with as a new
investor.
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 Four Types of Stocks
Growth Stocks
Growth stocks are the glamor investments on Wall Street.

They are the reason all those talking heads on CNBC have jobs and what makes Jim Cramer ramble
on as if he’s just chugged five Red Bulls. (Maybe he has.) Growth stocks often outpace the market,
and the best ones can earn triple-digit returns in investment in a short amount of time. So it’s no
surprise they generate so much excitement and endless chatter.

Of course, there’s a caveat to investing in growth stocks. Unlike time-tested dividend growers or
bargain-basement value plays, growth stocks carry plenty of risk. The companies are less mature,
often are subject to greater potential competition, and typically don’t pay a dividend. Thus, the stocks
can be very volatile.

For many investors, however, the risks of investing in growth stocks are
worth the potential rewards. Apple, Amazon.com (AMZN), Netflix (NFLX)
—all of them started off as growth stocks before they became some of the
market’s most coveted stocks. Those who got in early earned triple-digit,
even quadruple-digit, returns.

There are several keys to finding the right growth stocks:

• Invest in fast-growing companies. It’s a rather obvious prerequisite. But it’s important to know
what fast-growing means. It means investing in fast-growing industries, where revolutionary ideas
and services are being created. Any little-known stock that provides a product that is essential to
that budding industry makes for a good growth stock. Rapid sales and earnings growth is seen
among most big winners before their stocks take off.

• Buy stocks that are outperforming the market. Companies can promise all kinds of financial
growth. But is that growth potential translating to a rising stock price? The best investing tips
come from the performance of the stocks themselves; a rising stock tells you the smart money is
accumulating shares.

• Use market timing. Never underestimate the power of the market to move stocks. You don’t want
to invest in a growth stock just as the market is topping out, as three out of four growth stocks will
follow the trend of the overall market. If you’re in a bull market, you can afford to be aggressive in
buying stocks that are more speculative.

• Be patient. Not every growth stock will advance exactly when you want it to. Very few will, in fact.
Even Apple had plenty of fits and starts on its way to becoming the most valuable company in the
U.S. In the investment world, time is your friend. If you get out of a stock too early, you may miss
out on some big gains months down the road.

Growth stocks were the basis upon which Cabot Wealth Network (formerly Cabot Investing Advice)
was founded in 1970. Our founder, Carlton Lutts Jr., gave up a career in engineering to pursue his
passion for stock selection and market timing.

Nearly half a century later, we offer much more than growth investing advisories. But growth
stocks—and helping individual investors earn big profits from them—are still at the heart of what we
do via our flagship newsletter, Cabot Growth Investor.
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Investing in growth stocks can be tricky. Finding a hidden gem that has yet to be fully discovered
by the market is exciting, but requires lots of discipline to handle it correctly. Look for up-trending
earnings growth, improving profit margins, and booming industries. If done right, investing in
growth stocks can be both highly satisfying and highly profitable.

Dividend Stocks

Investing in stocks can be like buying a lottery ticket. You can have a very good reason to believe that
a stock is going to rise. But ultimately, it amounts to speculation.

Investing in dividend stocks is less speculative. It’s a good way to build long-term wealth.

A dividend is a sum of money a company pays to its shareholders, typically on a quarterly basis. The
higher the dividend payment, the higher the yield, which is calculated by the total annual dividend
payout per share by the current stock price. So, if a company pays $2.00 per share per year, and has a
stock price of $60.00, it has a yield of 3.3%. And any yield above 3% is considered good.

Dividend stocks aren’t solely dependent on their share price rising or falling. When you buy a
dividend stock, you know for sure that you’ll receive a steady stream of income—again, generally on
a quarterly basis. If the market crashes and the share price begins to fall, you at least have a nice 3%
or 4% yield (or higher) to soften the blow.

More often than not, you can trust a company that pays a dividend. Dividends are a measure of a
company’s success and its commitment to shareholders. The companies that consistently grow their
dividends are the ones whose sales and earnings are also growing. Companies that lose money or fail
to grow are unable to consistently pay a dividend.

When a company pays a dividend—and especially if it makes an effort to increase that dividend
every year—it shows that it cares about rewarding shareholders. Paying a dividend is also a savvy
way to attract investors, which is why shares of these stocks typically appreciate over time.

Dividend stocks aren’t going to make you rich overnight. But they can significantly build up your
nest egg if you buy and hold them for years, or even decades.

Not all dividend payers build wealth. You need to search for investments with timelessness and
longevity—companies that are sure to not only be around 20 or 30 years from now, but still thriving.
Dividend stocks become more powerful, and usually make up a larger part of your annual return, the
longer you hold on to them.

For example, if you had bought Wal-Mart (WMT) in April 1990, your
current yield on cost would be about 19%. That means you’d be collecting
19% of the value of your original investment every year from dividends alone!

With investments like these, it’s best to let your money work for you as long as
possible.

That can mean riding out some tough times. Wal-Mart declined 23% during the
2000 bear market, for example. Selling would have saved you some money in the
short term, but you also would have forfeited that 19% annual yield.
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When buying dividend payers, you have two options. You can either collect the quarterly income
or reinvest it to buy more shares. The latter is called a dividend reinvestment, and is an easy way to
increase the value of your position without having to do much. You can always start collecting the
dividends down the road when you need the income.

To help you find the best dividend stocks, we offer Cabot Dividend Investor, a service that gives you
regular dividend stock recommendations—and the tools to find some of the market’s best dividend-
paying stocks on your own.

Value Stocks

Notice any stocks that are getting pummeled as a result of embarrassing

headlines or negative rumors? They might be the next great value stocks.

Value investing isn’t as simple as that. But that’s sort of the mentality.

“Be greedy when others are fearful,” legendary value investor Warren
Buffett once said. His advice still rings true.

Sometimes good companies get wrongly punished by the stock market, often to the point where they
become undervalued. But not just any company receiving a bit of bad news qualifies as a good value
play. Instead, value stocks typically share a couple of key characteristics.

Those are:
• Strong growth prospects. Every stock takes it on the chin at one point or another. The companies
whose sales and earnings grow through it all are the ones that consistently bounce back. It doesn’t
take much for a stock to get knocked down—a disappointing new product, a scandal involving one
of its executives, a bad Super Bowl ad. Those are temporary problems. For savvy value investors,
they’re also prime buying opportunities.

• Cheap multiples. There are ways to actually measure value stocks. And it’s not as simple as
looking at the price to earnings (P/E) ratio, as some analysts might have you believe. Price to
earnings is just one of six major valuation benchmarks. The others are price to book value, price
to cash flow, price to dividends, price to sales and the PEG ratio, which is calculated by dividing
the current stock price by the last four quarters of earnings per share growth. For a company to be
considered a strong value stock candidate, at least one of those ratios needs to be low. If several of
those valuation multiples are low, and earnings are projected to grow, then you may have found a
stock that is trading well below its intrinsic value.

Even with those characteristics in place, successful value investing still depends a lot on timing. You
don’t want to invest in a strong value candidate while it’s still in free fall. You want to buy value
stocks right around the time they’ve hit rock bottom—or at least close to it.

Determining where that bottom lies isn’t an exact science. Rarely, if ever, are you going to get in at
the exact right time. A simple rule of thumb is to adhere to Benjamin Graham’s “Margin of Safety.”
Graham, universally recognized as the father of value investing, said the Margin of Safety is achieved
by buying a stock only when it’s trading below its maximum buy price, thus minimizing potential
losses.

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To learn more about value investing, and how to find undervalued stocks, you should consider
subscribing to our Cabot Undervalued Stocks Advisor newsletter. In it, analyst Crista Huff uncovers
stocks that combine elements of value and growth – companies that are growing at a very healthy rate,
but are still undervalued by the market.

Emerging Markets Stocks

As Americans, we often get so caught up in our own domestic issues that we

ignore what’s going on in the world around us. That leads to a rather limited
worldview—and in investing, it can be a costly one.

Emerging markets stocks are among the fastest-growing investments in the

global marketplace. The nature of emerging markets is what makes emerging
markets stocks so enticing.

Emerging markets are economies whose gross domestic product (GDP) is growing at a much faster
rate than more developed markets such as the U.S., Germany and France. Consequently, emerging
markets stocks often grow at a faster clip than the average stock in a more mature market.

China and India garner the most attention. But good emerging markets stocks can be found in other,
less populous corners of the globe, including South Korea, Mexico, Turkey, Saudi Arabia and South
Africa. The options are numerous for investors willing to explore outside their American bubble.

There are myriad reasons to do so. Investing in emerging markets stocks allows you to invest in
countries with double-digit GDP growth—or close to it. At a time when America’s economy is
expanding in the low single digits, Japan’s economy is struggling and much of Europe is still buried
under a mountain of sovereign debt, emerging markets hold more appeal than ever.

Of course, all emerging markets investing comes with its fair share of risk. The term emerging is really
a euphemism for “underdeveloped.”

Many emerging markets are plagued by political instability, inferior infrastructure, volatile currencies
and limited equity opportunities. In addition, some of the largest companies in emerging markets are
either state-run or private. There are simply more unknowns when investing in a market that is still
developing. And the less you know about a company, the more risk you take on when you invest in it.

One way to curb the risk is to invest in American Depository Receipts (ADRs) traded on U.S.
exchanges, which subjects the stocks to strict U.S. requirements.

For some investors, emerging markets stocks are simply too risky. But for many, the potential for
massive rewards is worth the extra risk.

If you’re part of the latter group, then you should consider subscribing to our Cabot Emerging
Markets Investor. In this advisory, analyst Paul Goodwin looks for promising companies benefiting
from the rapid growth of emerging market economies. 

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 How to Be a Successful Investor for Life

Successful investing involves much more than just stock selection, so I urge you to read the following
tips, the distillation of a lifetime in this business. And then re-read them as necessary over time, so
that you can truly make the best use of my recommendations.

Recognize that perfection in investing is impossible. Not all your investments will be winners.
Losses are a normal part of the business. Your goal is to ensure that your profits outweigh your losses,
and the best way to do that is to have an investing discipline.

Determine whether you’re dealing with a value stock, as recommended by our Cabot Undervalued
Stocks Advisor, or a growth stock, as recommended by Cabot Growth Investor, Cabot Top Ten Trader or
Cabot Emerging Markets Investor.

If it’s a growth stock, buy only if the stock’s main trend is still positive. If the news is good but the
stock’s behavior is not, trust the stock. Remember that the stock market is always looking ahead, and
that your best guide to the company’s future news is what the stock itself is doing today.

In healthy bull markets, remain heavily invested, remembering, again, to ignore the news. In bear
markets, hold a large cash position, remembering that capital preservation is goal #1. And remember
that bull markets always begin when the economic news is lousy, and bear markets always start when
the news is good. Again, the market is looking ahead. So learn to trust stock charts.

With value stocks, diversification is highly recommended. Because the timing of their advances
is unpredictable, holding dozens of value stocks means the average value of your holdings will
appreciate over time. Contrarily, with growth stocks, concentration is advised. Five growth stocks
can be plenty, particularly if they are in different industries, while 12 growth stocks is probably the
maximum you should contemplate.

Sell your growth stocks in the following circumstances:

a) when the stock’s uptrend ends, as signaled by a substantial high-volume drop below a previous
support level
b) when the stock fails to outperform the broad market over a period of 13 weeks
c) when a profit of 100% or more has been cut in half
d) when your loss exceeds 20% in bull markets and 15% in bear markets.

Don’t fall in love with your stocks, regardless of how big your profit or how well you think you
know the company. The worst place to focus your investment is your own employer’s stock, as it
concentrates your risk.

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 Five Reasons You Should Invest on Your Own

So now you know how to invest and what stocks to invest in. But I haven’t fully answered the biggest
question—the one that has likely prevented you from investing in stocks up until this point: why?

Well, that’s easy—though it’s not a short answer. Let me count the reasons:

1. Self-directed advice is not expensive. Financial advisors usually charge 1% to 2% of your

portfolio balance every year. That can really add up. Investment advisories on the other hand will tell
you exactly what to do to meet your financial goals—at a very small fraction of the cost of a financial
advisor.

2. Your circumstances can change. Stop us if this sounds familiar: You meet with a financial
advisor to set up an investment account, he or she puts you in a variety of mutual funds that fit your
investment goals at the time … then you go years without paying much attention to your account
other than to look at the total return listed on your quarterly statements.

But what if your investment goals change? What if you set up the account as a 30-something
newlywed just hoping to conservatively save for retirement, and now you’re a 40-something father of
two who wants to invest more aggressively to be able to afford to send both of them off to college in a
few years?

Those years can sneak up on you if you’re not paying close attention to what you’re actually invested
in. If you manage your own account, you’re well aware of what’s in it. You bought and sold all the
stocks yourself. And you know whether you want to be more aggressive, more conservative or more
diversified. If someone else is managing your investment account, it can inadvertently become an
afterthought.

3. Investing on your own is much easier today. Until the Internet came along, things were a lot
harder for self-directed investors. Advice was mailed to you, which meant it could be days before you
received an alert to buy—or sell—a stock.

Today, online investment advisories provide expert opinions on what stocks to buy and where the
market is headed. And online brokerage sites like TD Ameritrade or E*Trade Financial allow you to
create and manage your own investment accounts without having to hire a personal broker.

Put simply, the Internet has given self-directed investors more tools to do it themselves than ever
before.

4. Not all financial advisors are created equal. Even if you’re willing to spend the extra money
to have someone manage your money, you may not be better off. Some financial advisors just aren’t
very good. Many fail to regularly beat the market. Others may not have your best interests at heart,
convincing you to put your money in stocks you shouldn’t be buying because they take a percentage
of every transaction.

There are times when it’s best to keep a hefty portion of your savings on the sidelines. The shadier
financial advisors will try to convince you otherwise. And that again brings me back to my original
point…

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5. No one cares more about your money than you. There are plenty of honest financial advisors
out there. But is one of them managing your money? You may never know for sure. When you
manage your own portfolio, you—and you alone—decide where your money goes.

The Bottom Line

There’s less mystery surrounding investing in stocks on your own these days. With so much
information at your fingertips, do-it-yourself investing is much easier than it was 20 years ago.

And that’s what we do at Cabot Wealth Network—make your job as a self-directed investor easier. With
11 advisories offering a range of investment styles, you can find the advisory that matches your goals
today, and change to a different style as your goals change. If you’re willing to invest on your own,
we’re here to help—and have been since 1970.

Investing in stocks isn’t as scary as you think. Investing on your own is empowering and educational,
and profitable.

About Cabot 
Cabot is one of the oldest and most respected independently-owned financial advisory services in the U.S.  Our investment advisory
services  deliver high-quality advice to more than 200,000 individual investors and investment professionals in  141 countries. Our paid
subscribers number 25,000 in 78 countries.
 
Founded in 1970, Cabot publishes independent, high-quality research and investment advice grounded in sensible, time-tested investment
strategies for individual investors and investment professionals. Today, the Cabot family of investment advisories includes Cabot Growth
Investor, Cabot Top Ten Trader, Cabot Emerging Markets Investor, Cabot Small-Cap Confidential, Cabot Stock of the Week, Cabot Options
Trader, Cabot Options Trader Pro, Cabot Dividend Investor and Cabot Undervalued Stocks Advisor. To subscribe to any one of these advisories,
click here.

About Timothy Lutts

Timothy Lutts heads Cabot Investing Advice. He leads a dedicated team of professionals who serve individual investors
with high-quality investment advice based on time-tested Cabot systems. Timothy is also the chief analyst for Cabot Stock
of the Month and is a regular contributor to Cabot’s free email newsletter, Cabot Wealth Advisory.

176 North Street • P.O. Box 2049 • Salem, MA 01970 • Telephone 978-745-5532 • https://cabotwealth.com
This special report is published by Cabot Wealth Network. Cabot is neither a registered investment advisor nor a registered broker/dealer.

Neither Cabot nor our employees are compensated in any way by the companies whose stocks we recommend. Sources of information are believed to be reliable, but are in no way guaranteed to be complete or without error.
Recommendations, opinions or suggestions are given with the understanding that readers acting on the information assume all risks involved.

We encourage readers of this report to consult with an independent financial advisor with respect to any investment in the securities mentioned herein. Any opinions, projections and predictions expressed in this profile are statements
as of the date of this publication and are subject to change without further notice. Past performance may not be indicative of future results.

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