Your first stock: Make it stock in an exchange-traded fund

Q: I'm an investing novice and considering buying shares of Medtronic mdt. Is that a good first stock to buy?

A: When shopping for a first bicycle, you might look for fat tires, a low center of gravity and training wheels. Similarly, a long surfboard with more buoyancy might make for an excellent first board.

But a first stock? That's a little trickier because it depends mainly on you. Are you 80 years old, retired, on a fixed income and extremely risk intolerant? If that's the case, you might think about an exchange-traded fund (ETF) that owns Treasuries or other safe bonds. But if you're a 20-year-old attorney, making tons of money, getting job offers for even better jobs daily, you can afford to be more daring with your money and might consider a risky stock with more upside.

Also, what's your goal for your first stock? Do you want to buy something you can hold for a long time and watch it grow? Or, are you hoping to learn how to be a day trader and dart in and out of stocks hoping to make fast money?

Not knowing your stage in life, appetite for risk and objective for owning stocks, I'm not sure how to answer your question precisely. But what I can do is put the stock through the four steps we use to evaluate stocks so you can see if it fits what you're looking for.

As you probably already know, Medtronic is a leading maker of medical devices. That broad theme is interesting because it plays into the aging population. Also, health care can often be defensive during bad times because people don't forego critical medical treatment even if the economy is weak.

But, let's give this stock the complete workup:

Step 1: Risk vs. reward. When you take a risk on a stock, you want to make sure you're properly rewarded. Downloading Medtronic's trading history back to 1980, we see the company generated an average annual compound rate of return of 18.4%, including the current dividend yield of 1.4%. That is a healthy return if you consider the S&P 500 has posted a roughly 12.1% annualized return over the same time period, says IFA.com.

But to beat the S&P 500, you accepted high risk — standard deviation — of 40 percentage points. That's 170% greater than S&P 500's risk during the period. So to get a 52% higher return you accepted 170% higher risk. That's really not a great deal — and the tradeoff is something you want to be aware of when buying your first stock.

Step 2: Measure the stock's discounted cash flow. Some investors decide if a stock is pricey by comparing its current price to the present value of its expected cash flows. It's a complicated analysis made simple with a system from NewConstructs. When we run Medtronic's stock, we find it's rated "attractive." In other words, the current stock price is much less than what the company is expected to generate in cash over its lifetime. Using this analysis, it would appear Medtronic is worth a chance.

Transparent Value, another online service that uses discounted cash flow analysis, provides additional information. Transparent Value measures how likely it is for a company to achieve the business milestones necessarily to justify its stock price. This analysis comes to a very different conclusion than NewConstructs, saying Medtronic only has a 25% chance of reaching the goals investors have for it. Step 2 is mixed, showing that two respected methodologies take very different views of the same stock. That's not a bad lesson to learn.

Step 3: Compare the stock's current valuation to its historical range. BetterInvesting's Stock Selection Guide can help. If the company can increase earnings 13.8% a year the next five years that would put the stock in the "buy" range. That's a green light for investors who believe the price-to-earnings ratio will return to historical norms.

Step 4: Check the company's financial health. Before investing in any company, you want to make sure it's in good financial shape. A quick way to check is to look at where it falls on the USA TODAY Stock Meter, which ranks stocks from conservative (1) to aggressive (5). Medtronic scores a respectable 1.8 here. You can get a Stock Meter score for almost any stock by going to money.usatoday.com and putting the stock's ticker symbol or name into the Get a Quote box.

So, you can see this is a complicated stock. Whether or not you buy it depends on your interpretation of the four criteria we looked at. Also, look at the chart at left. This is a volatile stock.

You might pay extra attention to Step 1. Do you really want to take so much risk with your first stock when the payback could be so modest?

For a first investment, you might consider buying a diversified portfolio by buying shares of an exchange-traded fund (ETF) that already owns many stocks, such as the SPDR S&P 500 ETF spy, which owns the stocks in the Standard & Poor's 500. That way you're at least getting your fair share of return for the risk you're taking.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.