Wall Street might shrug off the likes of Amara Shaikh, Sharon Hoang and Janet Liu simply because they're giggly 11-year-olds with braces and backpacks. But if you want to make some serious money in the stock market, you'd be wise to take some pointers from these fifth-graders from Tom Matsumoto Elementary School in San Jose, Calif.
In a matter of 10 tumultuous weeks earlier this year, they earned double-digit returns on their stock portfolios -- about 10 times more than the average index fund.
The kids were participating in the Stock Market Game, a national education effort that allows youngsters to invest a hypothetical $100,000 portfolio like a grown-up -- selecting real stocks to buy and sell, paying trading fees and enjoying (or suffering) the consequences of their decisions. Forty-four kids at Matsumoto Elementary broke into 13 stock-picking teams and did so well that they won all 10 of the top awards in the San Francisco Bay Area.
We talked to six of these winners -- and the Midwestern winner of the Stock Market Game's essay contest -- to see whether their strategies could help all of us be better investors. Here are five lessons learned from the kids.
1. Buy what you know
Every time 10-year-old Ashley Wong sits down to write a report, she starts by searching Google (GOOG, news, msgs). When Courtney Nguyen, 10, is in the mall -- and that's often -- she notices that the Apple (AAPL, news, msgs) store is always packed. Ask 10-year-old Katie Thi and her friends where they got their cell phones, and four of six chorus "Verizon." (The two others don't have cell phones.)
Not surprisingly, all of these companies ended up in these girls' portfolios.
Sharon Hoang, Courtney Nguyen, Janet Liu
So did Southwest Airlines (LUV, news, msgs), which Amara's parents prefer when they fly; Sony (SNE, news, msgs), which made the TVs that are in Sharon's house; Barnes & Noble (BKS, news, msgs), where they buy books; and Walt Disney (DIS, news, msgs), for obvious reasons.
"They're all stocks that we use in our everyday lives," Amara said.
Ashley Wong, Amara Shaikh, Katie Thi
Is that an unsophisticated way to pick investments? Not according to Peter Lynch, who ran Fidelity Investments' Magellan fund from 1977 to 1990 and turned the fund into one of the nation's largest, thanks to spectacular market-beating returns. Lynch maintains in his book "One Up on Wall Street" that individual investors, particularly teens and "tweens," can be better stock pickers than the professionals. That's because they're more likely to be out in the world and following the latest trends and fads.
That's what led him to buy shares in such companies as Toys R Us and 7-Eleven -- both of which have since been bought out -- as well as shares in Limited Brands (LTD, news, msgs), which now owns Victoria's Secret and Bath and Body Works, when they were relatively young and untested.
Being an avid consumer and staying aware of how companies serve their customers is how you know whether a company's products have hit a nerve or are quickly becoming obsolete, Lynch wrote.
2. Do your homework
Janet was trolling the Internet for stock ideas when she ran across a recommendation for Goldman Sachs Group (GS, news, msgs). She started pulling up articles, its stock history and information about the company's finances. The more she learned, the more she liked it. She talked two teammates into buying shares in the investment banking company because her research indicated it had been hit unjustly hard by troubles in its industry and was due for a rebound. She was right. During the next few weeks, Goldman's shares soared about 38%.
Cameron Fisher, an 11-year-old from Kansas City, Mo., found Cracker Barrel Old Country Store (CBRL, news, msgs), a restaurant operator, in much the same way. Looking at five years' worth of stock price history, Fisher figured that this healthy and profitable company was due for a pop. Its gains helped fuel his team's 9% return over 10 weeks.
Picking stocks for profit isn't all about the consumer experience, though. Some of it is about the numbers. In addition to knowing what a company does, you need to investigate the company's finances and make sure you're comfortable with its trading price.
Generally speaking, a company would be a wise buy when its market price compared with its earnings -- that's called a P/E ratio in Wall Street-speak -- is below its historical average or below its percentage earnings growth. How do you know the historical average? You can find a company's average in Value Line investment reports, which are published on the Web and in books you can find in the library. (You can figure a company's current P/E by dividing its stock price by its earnings. In other words, if it sells for $20 a share and has $2.50 per share in annual earnings, its P/E is 8.)
What if the current P/E is high based on its history but you still think the company's a good buy? See how the P/E compares with the company's earnings growth. If the company's profits are growing 20% a year, a P/E of 20 could be reasonable. But experts contend that a higher P/E suggests that the company's stock is overpriced.
3. Trade sparingly
Warren Buffett, the chairman of Berkshire Hathaway (BRK.A, news, msgs), has become a billionaire through a simple investing philosophy: Buy good companies and hold them forever. That's exactly what Sharon, Courtney and Janet's team did, although "forever" for the purposes of the game was just the 10 weeks the game lasted.
The strategy is smart for two reasons. One is simply that while the market will have ups and downs, good companies will grow and prosper over the long term. When you own a piece of those companies, your portfolio grows with them.
The other reason is practical: In the game the kids were playing, they paid 2% of a trade in fees. That could diminish their overall returns. By buying four good companies -- Apple, AT&T (T, news, msgs), Goldman Sachs and Sony -- and sitting on their portfolio through the daily ups and downs, Sharon, Courtney and Janet saved those fees and produced a 27.9% profit. That equated to a mouthwatering annualized return of 145%. The market, as a whole, rose less than 3% while they were playing.
In real life, investors could find a discount broker and pay much less in trading fees. But they'd also pay capital-gains taxes every time they sold and took a profit. And short-term trading means paying at a higher capital-gains tax rate.
The fees-and-taxes combination makes trading a losing game, according to research done by finance professor Brad Barber, who teaches at the University of California, Davis, and Terrance Odean, a finance professor at UC Berkeley. Barber and Odean looked at real trading conducted by 35,000 households and concluded that active trading reduced annual returns by between 1.72% and 2.65% on average. The more you trade, the more it costs you.
4. Know when to sell
There are two times to sell a stock: when you realize your initial purchase was a mistake and when a stock's price has run up so far that you figure you would no longer buy it today.
Cameron loves Cracker Barrel, but it fell into the second camp. Cracker Barrel was selling for about $16 a share early in the year, when he was buying, but its price had more than doubled by April. Fisher figured that while the company was a bargain at $16, it wasn't such a buy at $33. He figured it was time to take some chips off the table. The move proved prescient: Cracker Barrel was selling for $29 last week.
Ashley, Amara and Katie love Southwest Airlines as a company. It has a good on-time record, which pleases their parents, and they appreciate the flight attendants' sense of humor. But the stock "was bringing us down," Ashley said. When they bought in mid-February, Southwest was selling for more than $7. It fell to $5 -- roughly a 30% loss -- within weeks and languished below their purchase price because of investor concerns about the economy and oil prices. The girls decided it wasn't the best time to hitch their fortunes to an airline. They sold the bulk of their Southwest holding and bought Verizon (VZ, news, msgs), which they figured would be less harmed by a tough economy.
5. Diversify
Ann Fleischer, who teaches fourth- and fifth-graders at Matsumoto Elementary, spent a few weeks on investment basics before her students started trying to trade stocks. One of the lessons she emphasized: Don't put all your eggs in one basket. The students needed to split their investments among different companies in different industries, she said.
That diversification saved Ashley, Amara and Katie, whose portfolio would never have recovered from the Southwest loss if they hadn't also had Disney and Google. Overall, Fleischer said, her students invested in an array of financial-services, technology, entertainment and retail companies. Only one of the 13 teams lost money, she said.
It was just a game, of course. But each of these keys to the kids' success is also a time-tested rule that everyday investors have probably heard. So why is it hard to follow them with real money?
"It's important to remember that it is a game, and these kids came in with a clean $100,000 -- not like those of us whose retirement accounts were decimated last year," Fleischer said. Still, "some of the parents asked if they could come and sit in on the class."
Source: MSN Money
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