How to invest $10,000 right now

By Harry Domash

You're not rich. You own a few mutual funds in a 401k or an individual retirement account. And you're ready to take the next step: to buy a few stocks with $10,000 or so sitting in certificates of deposit or languishing in a bank account.

But how do you get started?

Let's begin by admitting this much: All of us, no matter how good we are at stock picking, are going to pick an occasional loser. That's why diversification is important. How many stocks must you own? Opinions vary, but dividing your $10,000 into 10 chunks of $1,000 each is probably sufficient. With many discount brokers charging less than $10 a trade, the commissions won't be significant.

However, different folks have different investment needs. I'll describe three strategies, including links to screens to see today's picks. Feel free to mix and match the stocks turned up by the screens or stick with the strategy that best suits your needs.

I used free online tools to build these three screens. The first two use StockScreen123, arguably the most capable free screening tool available on the Web. The third uses the Finviz.com screener, which I find easier to use but not as capable.

As tools, screens work best if rebalanced every six months. Rebalancing means that after six months, you'd rerun the screen and update the portfolio based on the new screen results.

Screen No. 1: Big and safe

Big, solid companies in steady industries are a good place for risk-averse investors to start. Click here (registration required) to see which stocks the screen is turning up today.

From a pool of the largest U.S.-traded stocks, this screen pinpoints profitable companies with reasonably strong growth expectations that are in favor with the smart money and have strong price charts.

StockScreen123 uses somewhat arcane abbreviations to identify search parameters. For each suggested search term, I'll give you a description, with StockScreen123's actual parameter in parentheses. You'll need this information only if you want to modify my screen or replicate it with another tool.

Here are the details.

1A. Only the biggest need apply

I start by limiting the field to stocks with market capitalizations (shares outstanding multiplied by recent share price) of $20 billion or more. Only 250 or so stocks out of the more than 5,000 U.S.-listed stocks fall into this category.

Screening parameter: Market capitalization (MktCap) >= 20000. (The number refers to millions of dollars.)

1B. Profitability

These companies are always your best bets. Here's why:

Suppose that two companies both earned $1 million last year. But company A's shareholders invested $10 million to get that return while shareholders had to sink $100 million into company B to turn the same profit. Company A's shareholders are getting a 10% return on their invested capital versus 1% for company B.

Profitability ratios compare net income to some form of shareholder investment. Return on equity, the most widely used ratio, compares income with shareholders' equity, or book value. Many professional money managers require at least 15% ROE, and that's what I use.

Screening parameter: Return on equity (ROE%TTM) >= 15.

1C. Count the cash

Some companies report positive earnings but are losing money when you count the cash. Operating cash flow measures how much cash actually moved into or out of a company's bank accounts.

Stick with companies generating positive cash flow, which means that cash is flowing in, not out. Requiring a positive cash flow ratio ensures cash is flowing in the right direction.

Screening parameter: Cash flow (Pr2CashFlTTM) > 0.

1D. Get sentimental

We are looking for growing companies, and growth strategies work best when you stick with in-favor stocks. Analysts' buy-sell ratings are a good measure of this market sentiment.

Video: Why you must own stocks now

Companies such as Zacks Research and Thomson Reuters compile analysts' buy-sell advice into a consensus rating for each stock. They do that by assigning numeric values to each individual rating: strong buy (1), buy (2), hold (3), sell (4) and strong sell (5). The consensus rating is the average of the analyst ratings. So a 3 consensus rating means that, on average, analysts are advising holding a stock, while a 1.5 means that analysts are evenly split between "buy" and "strong buy."

I require a maximum rating of 2, which means that passing stocks must be rated "buy" or better by analysts, on average.

Screening parameter: Analyst recommendation (AvgRec) <= 2.

Institutional buyers such as mutual funds and pension plans account for most stock ownership. Thus, their participation is required to qualify a stock as in favor. Institutional ownership, which is the percentage of shares held by these savvy players, typically runs between 40% and 99% for in-favor stocks.

Screening parameter: Percent institutional ownership (Inst%Own) >= 40.

Finally, in the sentiment department, because earnings growth expectations drive share prices, we'll check analysts' long-term (five-year) average annual growth forecasts. For big-cap stocks, anything higher than 10% qualifies a growth candidate. Lower numbers equate to low expectations.

Screening parameter: Expected EPS growth for the next five years (LTGrthRtMean) >= 11.

1E. Charting a course

Contrary to the oft-repeated "buy low, sell high" credo, in my experience, stocks that have already outperformed the market are your best bets, and the stocks among those that are gaining strength are even better.

Relative strength measures how a stock has performed compared with the overall market. For instance, an 80% relative strength means that the stock outperformed 80% of all stocks.

I isolate stocks with strengthening price charts by requiring at least 50% relative strength over the past 12 months, increasing that to 65% in the past six months and to 75% for the most recent three months.

Screening parameter: One-year relative strength >= 50% (1 Year Price % Change -- Best in the Market, highest 50%).

Screening parameter: Six-month relative strength >= 65% (6-Month Price % Change -- Best in the Market, highest 35%).

Screening parameter: Three-month relative strength >= 75% (3-Month Price % Change -- Best in the Market, highest 25%).

Continued: The young Buffett strategy

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