How I Evaluate Stock Picks From Others

When you write a column about picking stocks, you get plenty of advice about what you should buy. I often find these suggestions wise and enlightening. One of my best-performing stocks, Seagate Technology (symbol STX), was suggested by my editor, for example. Another, KKR Financial (KFN), was a favorite of my son.

Readers have come up with some great calls, too. About a year ago, one reader asked me to look at Eaton Corp. (ETN), an Ireland-based capital-goods maker. At the time, the company was growing nicely, and the stock was selling for just 9 times earnings and yielding a healthy 4%. I told the reader I thought Eaton was a great value and bought some for my personal portfolio (at the time I didn’t have any cash in my Practical Investing portfolio). I’ve earned 71% on that holding in just over a year (returns and prices are through August 2).

But I have not always been wise enough to heed readers’ advice. One took me to task for selling Lockheed Martin (LMT), which I did last January at $96, for a 30% gain. I felt vindicated when the stock fell nearly 10% in the days after I sold because of uncertainty surrounding the federal budget.

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The fact is, though, that the reader’s argument was impeccable and completely consistent with the way I invest—or at least the way I try to invest. Lockheed is a strong company that is consistently profitable and pays a generous dividend. That’s the kind of stock I generally think you can hold for decades, regardless of short-term market swings. My punishment for failing to heed this wise reader’s counsel has been to sit on the sidelines as Lockheed shares soared another 29%, to $124, since my sale.

But people also give me advice that I can’t take—and won’t lament forgoing. That’s simply because their ideas are so far outside my comfort zone that acting on them would surely give me a stomachache.

For instance, a lot of people made a fortune buying gold, which nearly quintupled between 2002 and September 2011. Many gold enthusiasts urged me to jump on the yellow-metal bandwagon.

But I didn’t buy a single ounce, nor did I buy funds that track the metal’s price or invest in mining stocks. Why? I’m a numbers girl. And no one can provide a good formula for evaluating the right price to pay. Gold is essentially a hedge against fear. When people become worried about the economy or the value of their currency, they bid up gold’s price. But are they $500-an-ounce concerned or $2,500-an-ounce terrified? I know of no logical way of making that call, so I simply stay away.

High-P/E aversion. I feel the same about many popular stocks that sell at absurd price-earnings ratios. Take Amazon.com (AMZN). When one analyst told me in November 2011 that it was a screaming buy at $192—a price that amounted to about 100 times estimated 2012 profits—I thought he was nuts. Since then, the stock has soared nearly 60% even though Amazon lost money in 2012 and is expected to earn just 86 cents per share this year. At $304, the stock now sells for 354 times estimated 2013 profits.

Do I regret not getting in at $192? Not really. (Okay, a little.) But buying Amazon would have put me on pins and needles because I didn’t understand why the stock traded at such an exorbitant P/E—and, frankly, I still don’t. I would spend my days trying to figure out when sentiment for Amazon might sour. And that would make me miserable and nervous.

I want my investments to make me calm and comfortable, to meet my economic goals without turning me into a neurotic trader. Yes, I sometimes miss out on profits, but I save on antacids. That’s a trade I’ll make any day.

Kathy Kristof is a contributing editor to Kiplinger’s Personal Finance and author of the book Investing 101. You can see her portfolio at kiplinger.com/links/practicalportfolio.