How to pick stocks

Why stock picking matters

Stock picking is important because it can have a big impact on your returns. Choosing the right stocks can help you grow your portfolio over time, while the wrong ones can lead to losses.

Determining your investment strategy and goals

Before picking any stocks, it’s important to understand why you’re investing. Different investment goals require different types of stocks and different levels of risk.

Identifying investment goals

Most investors share the same goal: to grow their money. But how you go about that depends on what you need your investments to do. Three common types of investment goals are:

• Income generation: If you want steady cash flow, you might focus on dividend stocks that pay regular income. These are often large, established companies in sectors like utilities or consumer goods.
• Capital appreciation: If your goal is long-term growth, you might look for stocks with the potential to rise significantly in value. Value stocks are usually companies in their early growth strategies, like tech startups or newer innovators. This strategy involves more risk but also more potential reward.
• Wealth preservation: If you’re more focused on protecting your money than growing it quickly, you might lean towards stable, low-volatility stocks, like blue-chip companies or defensive sectors like healthcare or consumer staples.

Choosing an investment strategy

Once you’ve set your goals, the next step is choosing an investment strategy that matches your risk tolerance and what you want your portfolio to achieve. Three common investing styles are:

Growth investing

Growth investors look for companies with strong potential to grow revenue and earnings over time. These are often newer companies or businesses in fast-moving industries like tech or renewable energy.

Even if a company isn’t profitable yet, growth investors may still buy in if they believe it has a competitive edge or a promising future. The idea is to invest early and benefit as the company becomes more valuable.

Value investing

Value investors look for stocks that seem undervalued by the market. These companies may not be flashy or fast-growing, but they’re often industry leaders that are financially solid. The goal is to buy quality companies at a good price – essentially to find a bargain.

Income investing

Income investors want to generate regular cash flow from their investment, usually through dividends. These investors often go for large, established companies that return a portion of their profits to shareholders.

Understanding fundamental analysis

What is fundamental analysis?

Fundamental analysis involves estimating a stock’s intrinsic value by looking at financial and economic data. In other words, figuring out what a stock is truly worth based on the business behind it. The goal is to find solid companies that are well-positioned to grow or provide reliable returns over time.

When conducting fundamental analysis, investors consider both quantitative and qualitative factors.

Quantitative factors

These are objective, data-driven factors pulled from a company’s financial statements. They include:

• Earnings reports: These show how much profit a company is making. When earnings are increasing, it shows a financially strong company.
• Balance sheet: This lists a company’s assets and liabilities. In a healthy company, assets will be higher than liabilities.
• Dividends: If a company pays regular dividends, it’s often considered stable and profitable.

Qualitative factors

These are more subjective and focus on the company’s operations and reputation. They include:

• Company news: Positive developments can boost investor confidence while bad news can drive stock prices down.
• Leadership changes: New CEOs or executives might mean a shift in strategy or performance, which could have an impact on stock prices.
• Economic events: Interest rate changes, political developments, and other global events can affect company performance and investor sentiment.

Key metrics in fundamental analysis

Some key metrics used in fundamental analysis are:

• Earnings Per Share (EPS): This shows how much profit the company makes per share. A rising EPS usually means a company is growing.
• Price-to-Earnings (P/E) ratio: This tells you how much investors are willing to pay for $1 of the company’s earnings. A high P/E may mean a stock is expensive (or growth is expected), while a low P/E can signal a bargain – or a struggling company.
• Return on Equity (ROE): This measures how well a company uses investor money to generate profit. A higher ROE is usually considered better.
• Debt-to-Equity (D/E) ratio: This compares how much a company owes to how much it owns. A high D/E ratio can signal more financial risk, although a ‘good’ and ‘bad’ D/E ratio can vary by industry.
• Price/Earnings to Growth (PEG) ratio: This combines the P/E ratio with growth expectations. A PEG around 1 is often seen as fairly valued.
• Price-to-Book (P/B) ratio: This compares the stock’s market price to the value of the company’s assets. A P/B under 1 might signal a stock is undervalued.

Understanding technical analysis

What is technical analysis

Technical analysis involves evaluating stocks by studying price movements and stock trading volume rather than a company’s financial statements. The idea is that everything you need to know about a stock is already reflected in its price.

Technical analysts use stock charts, patterns, and indicators to try and predict where a stock’s price might go next. It’s especially popular amongst traders who focus on short-term price movements and want to identify opportune moments to buy or sell.

Key indicators in technical analysis

Some key indicators used in technical analysis include:

• Moving Average (MA): This smooths out price data to show the overall direction of a stock’s trend, filtering out short-term noise.
• Exponential Moving Average (EMA): This is similar to MA but puts more weight on recent prices to react faster to shifting market conditions.
• Moving Average Convergence Divergence (MACD): This compares two moving averages to spot changes in momentum. It’s often used to find possible buy or sell signals.
• Relative Strength Index (RSI): This measures the speed and magnitude of a stock’s recent price movements. An RSI above 70 can suggest a stock is overbought, while one below 30 might mean it’s oversold.

Combining fundamental and technical analyses

Fundamental and technical analysis can be used as separate approaches, or they can be combined to provide a more complete view when picking stocks.

For example, fundamental analysis can help you understand a company’s long-term value and financial health, while technical analysis can be used to find the right time to enter or exit a position based on market trends and price patterns.

How to integrate both analyses

Here are some tips for combining fundamental and technical analysis:

• Use fundamentals to choose stocks: Start by researching companies with strong earnings or solid growth potential. Look at things like P/E ratios, revenue growth, and return on equity to filter for quality businesses worth investing in.
• Use technicals to time your trades: Once you’ve found a stock you like, switch to technical analysis to decide when to buy or sell. For example, you might look for a MACD crossover to confirm momentum or an RSI below 30 to spot a buying opportunity.

Screening and selecting stocks

Stock screening is a quick way to filter through thousands of stocks to find ones that meet your specific criteria. Let’s dive into how this works.

How to screen stocks

Stock screening lets you scan the market for stocks in seconds rather than spending weeks conducting manual research. It involves applying filters to narrow down the list of potential investments based on specific criteria.

Some common filters you can apply include:

• Market capitalisation: Large, established companies will have a large market cap while early-stage companies will be small-cap
• Sector or industry: Do you want to invest in healthcare, tech, energy, or consumer goods?
• Financial metrics: You can filter based on EPS, P/E ratio, dividend yield, ROE, and more.

For example, if you’re a value investor, you might screen for stocks with a low P/E ratio and strong balance sheet. If you’re a growth investor, you might look for companies with high revenue growth and strong earnings potential.

Some popular stock screeners include:

• Morningstar
• Yahoo Finance Stock Screener
• Fidelity
• Finviz
• TradingView.

Most brokerage platforms also offer built-in screeners.

How to select stocks

Once you’ve screened for a handful of promising stocks, it’s time to dig deeper with thorough research and due diligence. To choose your stocks, you’ll need to look at:

• The company’s financial health
• Recent news or developments that could affect the stock’s performance
• Any red flags in management or legal issues.

Never skip this step! Screening helps you narrow down your list of stocks, but proper stock picking requires deeper research to get the bigger picture.

The "story" behind a stock pick

Every good stock pick has a story. This involves understanding the company’s competitive advantage, market position, and growth potential to give you more confidence in your investment decision.

Here’s what to consider:

• What does the company do, and why is it important?
• Does it have a competitive advantage?
• What are its growth prospects?
• How does it compare to its competitors?

Monitoring and reviewing stock picks

How to monitor stock performance

Here are a few ways to stay on top of your stock picks:

• Set alerts on your brokerage platform or a financial news site to get real-time updates on price movements or major announcements
• Create a watchlist to track both your current holdings and stocks you’re keeping an eye on
• Read annual reports and quarterly earnings to stay informed about company performance and future outlook
• Follow company announcements for major events like takeovers or product launches, which can move a stock’s price.

When to review and adjust an investment portfolio

Over time, market movements can throw your original investment plan off balance. This makes regular portfolio reviews essential.

It’s a good idea to review your holdings:

• After major market shifts
• When your personal goals or risk tolerance changes
• When a stock underperforms or outperforms.

Sometimes, you might want to rebalance your portfolio to align it with your original strategy. This might involve selling some investments that have grown too large, buying more of what’s underweighted, or removing underperforming or high-risk stocks that no longer fit your goals.

Tuning in to corporate presentations

Importance of corporate presentations

Corporate presentations are created specifically for investors and analysts to highlight a company’s recent performance, strategic priorities, and future expectations. Tuning into these presentations can help you:

• Understand how the company makes money
• Get a sense of the leadership’s vision
• Learn about upcoming products, partnerships, or market expansions
• Spot potential risks or challenges the company is preparing for.

How to access corporate presentations

Most public companies share their presentations and investor materials on the ‘investor relations’ page of their website. Other places to access corporate presentations are on earnings calls or at events and conferences.

Things to look for in a corporate presentation include:

• Revenue breakdowns
• Growth forecasts
• Competitive advantages
• Management commentary
• Plans for innovation, cost-cutting, or expansion.

Evaluating the success of stock picking

Is stock picking a successful strategy?

Stock picking can be successful if you’re willing to put in the time and effort to research companies and follow the market. Some examples of successful stock pickers include Warren Buffet, Peter Lynch, and Cathie Wood.

That said, even the best stock pickers make mistakes sometimes. The key is to understand risk, research heavily, and stay consistent.

Why is stock picking so difficult?

Stock picking can be difficult for a few reasons:

• Market volatility: Prices can change quickly due to unexpected news or global events. Stocks that look good today might fall tomorrow.
• Information overload: There’s an overwhelming amount of data out there, and filtering out what matters can be a struggle.
• Behavioural biases: Human emotions like fear or greed can easily get in the way, leading to poor decision-making or second-guessing.

Famous stock pickers

Who is the most famous stock picker?

The most famous stock picker is probably Warren Buffet, who’s known for his long-term, value-based approach to selecting stocks. Buffet looks for strong companies trading below their intrinsic value, and his firm Berkshire Hathaway has delivered consistent returns for decades.

Other famous stock pickers include Peter Lynch, the former manager of the Magellan Fund, and Cathy Wood, founder of ARK Invest.