How to Choose a Stock: The Basic Best Practices For New Investors

You've decided to invest. It's obvious that a low PE ratio is better than one with high levels. Also, a company that has a lot of cash is more likely to have a debt-laden balance sheet. Analysts' advice should be taken with a grain. You also know the number one rule for smart investors: Diversify your portfolio across different sectors.

This covers all the basics, regardless of whether you have delved into the more complex concepts of technical analyses. Now you are ready to choose stocks.

But wait! There are tens of thousands upon dozens of stocks available. How do you choose which ones to buy? Experts agree that it is impossible to look through every balance sheet and find companies with favorable net debt positions or improving their net margins.

KEY TAKEAWAYS

If you are using a stock screener it is susceptible to errors. Although it is possible to ride the back of institutional investors, you should be aware that they tend not to trust in safe blue-chip stocks which may or may NOT provide the highest returns.

How to Choose a Stock

Three things are common to smart stock-pickers:

Set Your Goals

The first step in picking investments is to determine the purpose of your portfolio. While everyone's goal is to make money, investors might be more concerned with generating income in retirement, preserving their wealth or capital appreciation.

Each goal requires a different strategy.

Every stock purchase decision is explained by a thoughtful investor.

There are three types of investors

Income-oriented investors are focused on holding stocks in dividend-paying companies and buying them (and keeping them) regularly. These are usually solid, but low-growth companies such as utilities. You also have bonds and real-estate investment trusts (REITs).

Wealth preservation investors have a low tolerance of risk due to their circumstances or by nature. They are more inclined to invest in blue-chip, stable corporations. They may focus on consumer staples and companies that are profitable in both good and bad times. They don't chase initial public offerings.

Capital appreciation is what investors seek out when they are looking to invest in stocks of companies that are at their peak growth years. They will take greater risks in order to make big gains.

Diversified Portfolio

These investors might combine any combination of the strategies. This is actually one of the main reasons for diversification. An investor who is conservative can allocate a small amount of his portfolio to growth stocks. To offset losses, a more aggressive investor will allocate a portion of his portfolio to solid bluechip stocks.

The hardest part is deciding which category you belong to. It can be difficult to choose the right stocks.

How to Choose a Stock

Keep your eyes open

It is vital to stay up-to-date with market news and opinions. Passive research is when you read financial news and keep up to date with industry blogs written by people who share your interests. An investment thesis can be built from a news article or blog post.

It can be common sense observation that underlies the argument. You might notice, for example, that emerging market nations produce new middle classes comprised of consumers who are more interested in a wider range of consumer goods. There will be an increase in demand for certain commodities and products as a result.

Stock Picks: The Story Behind the Stock Pick

The investor can take the argument one step further and conclude that if there is more demand for a product some producers will prosper.

This basic analysis is what makes a stock worth buying.

It's also important to question your assumptions and theories. While you may be a fan of fast cars and doughnuts, it doesn't necessarily mean that those in Southeast Asia have a greater desire for them.

After you have completed qualitative research, you can now begin to understand the argument by reading corporate press releases or investor presentations.

Find Companies

Next comes the identification of companies. It is possible to do this in three easy steps:

  1. Look for ETFs that track the performance in the industry you are interested and then check out which stocks they're holding. It's as simple as looking for "Industry X ETF". The fund's top holdings will be revealed on the official ETF page.
  2. To filter stocks by specific criteria such as industry and sector, use a screener. Screeners allow users to filter stocks based on specific criteria such as sector and industry.
  3. For commentary and news on companies within the investment area you are interested in, search the blogosphere, stock analyses articles and financial news release for information. Be critical of all you read and examine both sides of an argument.

Although these three options are not the only way to choose a company, they offer a good starting point. Investors should also consider the clear advantages and drawbacks of each strategy.

Although it is difficult to find expert opinions through news sources, it is possible to get results. This will help you to understand the fundamentals of the industry. You may also be able to identify smaller companies that aren't listed on screens or in ETF holdings.

Tune in to Corporate Presentations

Once you have decided that the industry you are interested in is worth your investment, and are familiar with all the major players, you can turn your attention towards investor presentations. Although they are not as comprehensive as financial statements but provide an overview of how companies make money, they are much easier to understand than 10Q or 10-K.

These reports will also include forward-looking information about the industry and the direction the company is heading. You can refine your search by browsing company websites and presentations.

This involves more detailed scrutiny of a company to determine if it could outperform its peers in the industry.

The Next Step

You may end up with one investment prospect or a list containing ten companies.

You may decide this industry is not for you. That's fine. You might have been able to avoid making a poor investment because of all that research.

It is essential to know when to say no in order to pick stocks. You might be ready to pull the trigger or you might act like a professional in financial industry and perform an detailed financial statement analysis .