Bottom Line/Personal: The typical investor does not have access to all of the data and tools that the pros have. So, how can the average investor become better at picking stocks?

I’m Steven Kaye, editorial director of Bottom Line Publications, and this is Bottom Line On Your Money, where our experts help you create, invest and protect your wealth.

Today I’m speaking with Vahan Janjigian, PhD, CFA. Vahan is editor of the MoneyMasters Stock Report newsletter, chief investment officer at Greenwich Wealth Management and author of two books, including Even Buffett Isn’t Perfect. Vahan previously served as editor of the Forbes Special Situation Survey newsletter, where he was ranked the number-one stock picker by Hulbert Interactive for the decade ending in December 2012.

Vahan, the average investor doesn’t have multiple terminals at home with all the data that pros have, so how can the average, typical investor become better at picking stocks?

Vahan Janjigian, PhD, CFA: Well, there’s an easy way and there’s a hard way. Let me tell you the hard way first, because it’s really the only theoretically correct way to determine what any stock is worth, and that’s to do a discounted cash-flow analysis. Unfortunately, this takes a lot of training and a lot of expertise—this is the backbone of the Chartered Financial Analyst Program—so it’s not something that the average investor will do…or even can do.

But there are other things that they can do that seem to be very effective over time and cause you to pick stocks that do well in the long run. There have been a number of academic studies on this, and the studies show strongly that the stocks that do best over the long term tend to be value stocks rather than growth stocks, and they also tend to be small-cap companies rather than large-cap companies. So as an average investor, you want to focus on small-cap, value stocks if you are a long-term investor.

What does that mean? That means that you want to primarily—not exclusively, but primarily—have in your portfolio small-cap companies—and these would be companies that, for example, might have market caps of less than $2 or $3 billion. And you want to have companies that are value stocks. One way to determine whether a company is a value stock or a growth stock is to look at the price-to-book ratio.

Bottom Line: You can find the price-to-book ratio on many websites. It’s not an unusual number or an archaic number.

Janjigian: Correct. It’s readily available, just like the price-to-earnings ratio. It’s readily available. But the price-to-book ratio, it turns out, is a much more reliable way of picking stocks. Another one is the price-to-sales ratio—that also seems to be a reliable way of picking stocks. So you want to pick stocks that have low price-to-sales ratios or price-to-book ratios.

But you also want to make sure that you’re diversified. Keep in mind that what may be low in terms of price-to-sales in the technology industry could be very high in the utility industry.

Bottom Line: OK, so if you’re looking at price-to-book or price-to-sales, what constitutes low? How do you know?

Janjigian: Low would be low compared to the peers in the same industry. So you want to compare them to other stocks in the same industry. Sometimes you can get what’s known as an industry average—that might be available on the web. But just use common sense. If you have to pay 20 times sales for a stock, then that’s not a cheap stock. But if you can buy a stock for only one or two times sales, it might be worth putting in your portfolio.

Bottom Line: Vahan, it’s never easy, but I think you just helped our viewers cut through at least some of the uncertainty in picking stocks, because if they focus on some small-caps and value stocks, they will at least give themselves a leg up on many other investors who don’t look at those areas.

Janjigian: That’s right.

Bottom Line: Thank you.

Janjigian: Thank you, Steve.

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