September 7, 2010 - Warren Buffett once said: "Prior to that, I had been investing with my glands instead of my head." He was referring to his tutelage by his mentor, the great Benjamin Graham, the father of fundamental investing. After learning how to analyze a stock, he realized that he'd been buying stocks more with his emotions than his brains. He put his brain to work, and the rest is history.

How often have we heard a great story and simply bought the stock? I have. Too often. A talking head (sometimes screaming) lays out all the reasons a stock is a great buy, urges investors to put in their orders. Eager investors write down the symbol and if the market's open, they buy it. If they have to wait until the next day, they buy it at the opening bell, along with thousands of others who heard the same message, pushing up the price instantly.

If you've done this (and I have), you'll know what happens next. The price starts to fade soon afterwards, slipping with every tick, moving lower as the histeria and hype give way to reason and reality. The people who sold the stock to eager buyers are much happier than the new owners as they watch the stock fade down to levels below where they bought. I've done it enough to stop. I urge you to do the same.

The best way to put your emotions in check is to have a check list of what you want out of a stock. Do you need income? Then buying a new biotech with no track record doesn't belong on your wish list. Or if you have capital gains as a goal, then utilities and other high dividend paying stocks won't get you there. Of course, putting together a whole portfolio is optimal: some income, some defensive stocks, some aggressive. The mix should be such that no one sector overwhelms the others.

You may object at these selections, pointing out that these stocks haven't been stellar performers over the last several years. But only a lucky few investors got in great stocks, ones that went up dramatically in spite of a market that has been sideways this year and down noticeably since 2000. Remember that investing is a long term commitment and that owning quality stocks for meaningful periods of time has proven to be a very powerful way to make money. Example one: Warren Buffett. In his own words: My favorite holding period is forever.

Another screen to use: Price to book value. This is a way of buying dollars for pennies. Book value is the value of the equity of a company, the part shareholders own. (Book value is easily obtained from most quote programs.) If book value is $5.00 a share and the stock is selling for $4.50, that means you're buying $1.00 of value for 90 cents. Of course, the stock has to continue to add to earnings if you are to be successful in the company as an investment. If it does, then most of the time, the discount to book value goes to a premium.

One more easy screen: a low P/E ratio. This is the Price divided by the Earnings. The lower the P/E is, the "cheaper" the stock is. When you buy a stock, you are buying the future flow of earnings. If those earnings are increasing and you're buying them at a relatively low valuation, then you have the odds in your favor of making money. Another way to look at the P/E (thanks to Peter Lynch, one of the great fund managers), is to think of the P/E as the number of years it will take you to make you investment back. If a P/E is 5, and the stock makes the same earnings every year for 5 years, you will make have your investment returned in that time. If the P/E is 50, then you better hope earnings aren't stable but growing extremely fast because 50 years is a long time to wait for a pay day.

These are very basic approaches for how to look at a stock, but they do engage the brain. They will go a long way in helping you avoid the "sizzle" of a great story and focus more on the real meat of the stock.

- Ted Allrich