How to Select High-Profit and Low-Risk Stocks

High-profit, low-risk stocks are still a gamble on the stock market.

It is believed that highly profitable stocks are less risky than low-profit companies, because earnings drive share prices. It depends, however, on how you define high profit and low risk. Learn how to define profit and risk, so you can select high-profit and low-risk stocks.

Things You'll Need

• Access to the Internet

Instructions

1. Define high profit. There are many ways to define highly profitable; we can use earnings growth rates, profit margins or total net profits, to name a few. For example, Company A has a quarterly earnings growth of 17 percent, net profit margins of less than 10 percent and net profits of $11 billion. Company B has a quarterly earnings growth of 30 percent, net profit margins of 25 percent and net profits of $1.3 million. Which company is more profitable? It depends. Most investors focus on earnings growth rates because Wall Street is mostly concerned with future expectations rather than past profits. For purposes of this article, let's define high profit as a company that has yearly earnings growth of more than 50 percent.

2. Define risk. A common definition of risk is beta. Beta measures a stock's movement in relation to the overall market. For example, if the market drops 1 percent, a stock with a beta of 2 will drop by 2 percent, making it riskier than the market. When the market drops by 1 percent, a stock with a beta of .5 will only drop by .5 percent, making it less risky than the market. The same principle applies on the up side. Remember, more risk, more return. Not only is beta a good measure of risk, most detailed quote screens display beta, so it is easy to find.

3. Search for stocks that meet your high-profit, low-risk criteria now that you have it set. Many financial websites have stock screeners that are easy to use. If you have an online brokerage account, it should also provide a stock screening tool. For the sake of the examples being used in this article, we will use the Yahoo! Finance stock screener.

4. Go to Yahoo! Finance and navigate to the Stock Screener page. Scroll down to the section titled "Share Data." Find Beta. Select a beta figure of 0.5 to indicate we want stocks that move less than the overall market. In other words, when the market drops by 1 percent, stocks with a beta of 0.5 will fall by only 0.5 percent. Also, when the market rises by 1 percent, stocks with a beta of 0.5 will rise by 0.5 percent. That is the risk/reward trade-off.

5. Select high-profit stocks by scrolling down to the section titled "Analysts Estimates." Screen for companies that have earnings growth estimates of more than 50 percent. In this example, search for companies with five-year growth rates estimated to be more than 50 percent. In the item "Est. 5 Yr EPS Growth:" select "Up more than 50%."

6. Click "Find Stocks." If the resulting list seems daunting, narrow the screen by adjusting your beta rates and growth estimates.

Tips & Warnings

• Use the stock screener to fine tune what levels of profit/earnings and risk you can tolerate by changing the variables in the stock screener and studying the stocks on the list for suitable investments.

• Just because you pick high-profit, low-risk stocks does not mean they will remain highly profitable or a low-risk item. Things change, so make sure you monitor your investment selections and that they match your investment goals, objectives and risk tolerances.

References

• CNN Money: Stock Investing
• The Motley Fool: Stocks for the Long, Long Run