Make no mistake about it, we believe in buying high-quality, individual stocks when the risk is low and the price is right. So even though your broker and mutual fund managers may not like it, we're going to level the playing field and show you how the successful Wall Street pros choose a good stock. (This is the same criteria Ken and I use.)

You can get all of the following information simply by asking a broker or, better yet, by researching a little yourself. All you need is a newspaper with a good business section, Value Line and Standard & Poor's and the company's annual report, which you can obtain at AnnualReports.com. With these items in hand, here's what you need to know to evaluate a stock - and exactly where you'll find it:

1. Market niche (you'll find this in the annual report). What does the company do? You want a company in a growing field. But beware of single-product companies: a company carrying all their eggs in one basket is too risky for your money.


2. Earnings per share (Value Line/Standard & Poor's). Earnings are a good indication of a company's growth. Look for strong and consistent and/or improving earnings in at least five of the last 10 years.


3. Dividend (VL/SP). Steadily rising dividends and uninterrupted dividend payments over the last 10 years are both signs of a healthy company.


4. Liquidity (VL/SP). Make sure the company has at least 5 million shares outstanding. This allows you to buy and sell your stock when you want.


5. Debt versus equity (annual report). Look for a company with three times as much equity as debt on its balance sheet. High debt means high risk. A company with more than 25% debt may have trouble meeting its obligations in difficult times.


6. Price-earnings ratio (newspaper). The P/E ratio (also called a stock's "multiple") is the current stock price divided by the annual earnings per share. It reflects a stock's growth potential and how expensive the stock is. To evaluate a stock's P/E ratio, compare your stock's P/E to the industry average (in Value Line.) If the stock's P/E is higher than the industry's, it may be overpriced; if it's lower, it may be undervalued and an attractive buy.



Straight Talk Tip: A fairly-priced stock will have a P/E roughly equal to its growth rate. Ask your broker for the company's growth rate and compare it to the P/E.

7. Inventories (annual report). Inventory buildup is a bad sign for a manufacturer or retailer. Big inventory probably means slow sales. Check under "management's discussion of earnings" in the annual report to find the inventory status.


8. Cash flow (VL/SP). The money a company takes in as a result of doing business is called cash flow. An average stock has a 10% return on the cash it spends; a 20% return on cash is excellent. For example: A stock selling for $10 with $1 per share in cash flow is average; $2 per share is excellent.


9. Pension plans (annual report). Make sure the company's pension fund assets exceed the "vested benefit liabilities." Pension plans, like bonds, are financial obligations that must be paid. A shortfall could spell financial trouble.

Now, the next time some flashy broker calls you trying to sell you the "idea du jour," "sure winner," or "the next Xerox," ask your broker how the stock stacks up to the above criteria. You'll quickly learn that the person on the other end of the phone doesn't always know the important facts about the company.

For more information, pick up One Up on Wall Street by Peter Lynch, Ken's college classmate at Boston College.

Learn more about stocks and smart investment strategies:

• How to Read Stock Quotes 101
• Dolans 10 Simple Rules of Investing
• Your Investing Mantra