Ultimate Guide on How to Choose a Stock

Investors want to learn how to choose the best stock. These steps will help you get started if you are a beginner stock picker.

There are many ways to choose a stock. To select a random portfolio, you could train a chimpanzee how to throw darts at the newspaper's financial section. Wall Street would be beaten by the chimp half of the time.

There are other ways to choose stocks if you don't want to train chimps or can't find a newspaper. You have an advantage over Wall Street's short-term view if you are an individual investor who has a long-term horizon for your stock purchase.

Step-by-Step Guide

1. Identify your investment goals

Every investor has different goals. Young investors will likely be more interested in growing their portfolio over a longer time period. As they approach retirement, older investors will likely be more concerned with capital preservation and planning to live off their investments. Investors are also interested in regular income through dividends and distributions from their investments.

Think about your goals for your investment portfolio. There are no set rules. There are no rules. You can be in your 60s looking to grow your portfolio or in your 30s looking for stability and additional investment income.

The companies you choose to purchase will depend on your goals.

2. Look for companies that you can understand

You become a part owner of the business when you purchase stock. You are setting yourself up to fail if you don't know the business.

You wouldn't trust yourself to assume full ownership of a business that you don’t know. How can you know if the management you hire is doing a great job?

There are companies everywhere. There are many products and services that you use every day. Take a moment to look at the companies behind them.

You should also consider companies that could indirectly impact your life. Many businesses do not deal with customers directly. Who makes the machines that accept your payment when you check out at the supermarket? Who is actually producing the medicine when you go to the pharmacy to buy your medication? What equipment is used? Where do mechanics buy spare parts and what equipment are they using? Who is responsible for building new towers or making the equipment to go on them?

The companies you come across every day can be used as a starting point for research into different industries and to find competitors. You can either do more research on how a company makes its money or you can find another one.

3. Find out if a company has a competitive edge

It's time to narrow down your list after you have reviewed a lot of companies and their competition. A company must have a sustainable competitive edge. This is what Warren Buffett refers to as a moat.

Buffett stated in 1999 that investing does not involve assessing the impact of an industry on society or its growth, but rather determining the competitive advantages of any company and the sustainability of those advantages. Investors will reap the rewards of products and services with a wide, sustainable moat around them.

There are many sources of a moat. Learn about the factors that can give a company an edge over its competitors, such as scale, switching cost, unique brands and intellectual property. This will help you to identify them in the companies that you are researching.

4. Set a fair price on the stock

After narrowing down your list to stocks that have a strong competitive edge, it's time for you to begin looking at stock price.

There are many ways to assess a stock's current value and determine if it is a good investment. Here are some:

5. Stocks with a safety margin should be purchased

Stock picking involves buying companies that are trading below your estimates for a fair price. This is your margin for safety. This means that if you aren't satisfied with your valuation, you can avoid big losses by purchasing at a lower price than your fair value. This is another reason Warren Buffett has been a successful investor.

A stock with strong earnings and an optimistic outlook might not require a large margin of safety. You'll likely be fine if you take 10% off your target stock price.

You may need a greater margin of safety for growth stocks that have less predictable earnings. Depending on your confidence in your valuation, aim for 15%-30%. This ensures that you are protected if something doesn't go according to plan.

You don't have to pay the lowest possible price for stock. You can trust that you did all the research required to make an informed decision. If the price is right, then take it.

You're sure to make winning investments if you follow these steps.