When you finally decide to start investing, you need to know some knowledge about stocks. You ought to understand that a low P/E ratio is usually better than a high P/E ratio. Across multiple sectors, your portfolio needs to be diversified. Naturally, the company with a lot of cash in its balance sheet is much better than the one excessively burdened with debt. Analyst’s recommendations must always be taken with a grain of salt. Now that you know the more complicated concepts of technical analysis, you are ready to pick stocks.
Tens of thousands of stocks exist. Thus, there is a question: How do you select an equity investment? The option of going through every income statement and balance sheet is an impossible feat. You can’t go through every companies’ favorable net debt positions are improve their net margins. Choosing an investment based strictly on the criteria inputs of a stock screener does not produce a full representation of the company and is prone to error. Finally, institutional investors of coat-tailing won’t usually help you to find any fund managers who tend to focus primarily on safe blue-chip stocks.
The first step to pick stocks is to determine the purpose of your portfolio. Investors focused on capital appreciation requirements, capital preservation, and income will have different investment criteria. Income-oriented investors are usually focusing on low-growth firms in industries and sectors such as the utilities. Moreover, although other alternatives such as master limited partnerships and REITs are also readily available. Those who are primarily concerned with capital preservation and have a low-risk tolerance tend to invest in stable blue-chip corporations. Thus, investors who look for capital appreciation are targeting companies of life cycle stages and ranging market caps.
Strategies on How to Pick a Stock
Anyone of the investor types mentioned above can use a combination of the above procedure, keeping diversification in mind. Nevertheless, the natural part is deciding which category you fall under. The Process becomes more complicated when figuring out which stocks to pick. A basic strategy should help investors narrow down their search before they start to analyze the financials of a firm. Nevertheless, there is no single correct method on how to go about picking stocks. So fundamental a strategy must help investors narrow down their search before they start to analyze the financials of a firm.
It is essential to stay current on opinions and current events to be an informed investor. Reading financial news online, magazines, and blogs is a simple form of passive research. Moreover, a person can do it daily. Sometimes, a blog post or a news article will form the foundation of an underlying investment thesis.
Reading a newspaper article about a significant acquisition is spurring further research into the fundamentals which drive that particular industry. The Internet is providing a tremendous level of convenience. There, any major event is analyzed through multiple perspectives by different investment professionals. Sometimes the main argument can be simple as there is a current movement away from poverty in the newly emerging markets, which causes an increased number of people trying to cross the border into middle-class status. It results in a surge in demand for product/commodity Y. If we take this argument one step further, the investor will be able to deduce that with an increase in the need for Y, producers of Y will most likely prosper.
The Stock Picking Process
Behind the investment, this type of fundamental analysis forms the basis of the overall story. It is justifying purchases of any share in the specific industry of interest. An essential research requirement is to scrutinize the theories and assumptions of the original argument: If the supply of Y is infinite, an upward demand push will probably have minimal effects on companies in the business of selling/producing Y. When you are convinced and comfortable with the general argument after performing this form of qualitative research, corporate press releases and investor presentations are reporting the right place for continued analysis.
The next stage involves finding the companies in which you may be potentially interested in the stock-picking Process. There are three ways for doing it:
- Find ETFs which are tracking the performance of the industry. Then check out their holdings. That might be as easy as to search for Industry X ETF; the official ETF page will be disclosing either only the top holdings or all of the funds.
- Based on a specific criterion, such as the industry and sector, use a screener for filtering stocks. Screeners offer additional features to the users. For example, to sort companies based on dividend yield, market cap, and other useful metrics of investment.
- Search through the articles’ stock analysis, releases of financial news, and blogosphere for ideas on companies in the chosen investment space. Always keep in mind to be critical of everything you read and always analyze both sides of the argument.
Probably the quickest way of narrowing down your search is to search for companies based on ETF holdings. Nevertheless, ETFs typically hold only the largest companies in the space, most of the time ignoring small cap and micro corporations. These types of funds are also tending to focus on domestic markets. Stock screeners offer an excellent alternative for narrowing down the list of companies subject to desired inputs.
Moreover, screeners are providing a more comprehensive securities list which is including international firms. The investment metrics are usually somewhat misleading. The most time-consuming alternative is seeking out expert opinions via news sources. Nevertheless, it is undoubtedly carrying significant advantages. Firstly, reading stock analysis pieces is furthering your knowledge of the fundamentals of the industry. Secondly, investors often come across junior companies, which can neither be found within ETF holdings or through screeners. Finally, research at this stage cuts down your subsequent research time later on in the stock-picking Process.
It is time to turn your attention to investors’ presentations because you are already convinced that Industry X is a substantial investment, and you are familiar with the major players. Presentations are less comprehensive than financial statements. Nevertheless, they are providing a general overview of how firms make their money and are much easier for browsing through than 10-Q and 10-K reports. Presentation reports usually have forward-looking information on the expected direction of the industry and its company. The previous tips of performing a screen or going through funds holdings will, for sure, produce a large number of potential equity investment options, looking through company presentations and websites to let you further refine your research.
The information of the investor presentation report is including such materials as the general industry overview, future growth opportunities, operational highlights, and balance sheet/income statement/cash flow statement performance. The analysis of presentations involves more in-depth scrutiny of the actual company for deciding which particular stock is likely to outperform one of its competitors. Now what is left is to determine which companies are most attractive based on the presented information and narrow down their search once again. A crucial consideration is that the purpose of an investor presentation report is giving the company a chance to put its best foot forward.
I think that’s enough for today’s lesson. We will meet again next week.