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Table of ContentsHow to Pick a Stock Determine Your Goals 3 Types of Investors The Diversified Portfolio Keep Your Eyes Open The "Story" Behind a Stock Pick Find Your Companies Tune-in to Corporate Presentations The Next Step Stock Picking FAQs
By ARTHUR PINKASOVITCH, Updated August 02, 2022
Reviewed by THOMAS J. CATALANO
Fact checked by RYAN EICHLER
So you've finally decided to start investing. You already know that a low P/E ratio is generally better than a high P/E ratio, that a company with a lot of cash on its balance sheet is superior to one burdened with debt, and that analysts' recommendations should always be taken with a grain of salt. And you know the cardinal rule of the smart investor: A portfolio should be diversified across multiple sectors
That pretty much covers the basics, whether or not you've waded through the more complicated concepts of technical analysis. You are ready to pick stocks.
But wait! With tens of thousands of stocks to choose from, how do you go about selecting a few worth buying? Whatever some experts suggest, it's just not possible to comb through every balance sheet to identify companies that have a favorable net debt position and are improving their net margins.
Smart stock-pickers have three big things in common:
The first step to picking investments is determining the purpose of your portfolio. Everyone's purpose for investing is to make money, but investors may be focused on generating an income supplement during retirement, on preserving their wealth, or on capital appreciation.
Income-oriented investors focus on buying (and holding) stocks in companies that pay good dividends regularly. These tend to be solid but low-growth companies in sectors such as utilities. Other options include highly-rated bonds, real estate investment trusts (REITs), and master limited partnerships.
Any of these investor types might use a combination of the above strategies. In fact, that's one of the prime motives for diversification. A conservative investor can devote a small portion of a portfolio to growth stocks. A more aggressive investor should earmark a percentage for solid blue-chip stocks to offset any losses.
Warning: A stock screener, if you use one, is prone to error. Riding the coattails of institutional investors is an option, but you should know that they tend to rely on safe blue-chip stocks that may or may not provide the best returns.
It's vital to keep up with market news and opinions. Reading the financial news and keeping up with industry blogs by writers whose views interest you is a form of passive research. A news article or blog post can form the foundation of an investment thesis.
Important: The thoughtful investor has a 'story' that explains every decision to purchase a stock
Taking the argument a step further, the investor can deduce that with an increase in the demand for a product, some producers of that product will prosper.
The next stage in the stock-picking process involves identifying companies. There are three simple ways to do it:
Once you are convinced that the industry that interests you is a solid investment and you are familiar with the major players, it is time to turn your attention to investor presentations. They are less comprehensive than financial statements, but they provide a general overview of how firms make their money and are easier to absorb than 10-Q and 10-K reports.
At the end of your research process, you may be left with a single investment prospect or a list of ten or more companies.
Is Stock Picking a Successful Strategy?
Stock picking, also known as active investment management, tends to regularly underperform a passive strategy that tracks the broader stock market indexes. In fact, research shows that more than 90% of stock pickers underperform over a 15-year period.
Who Is the Most Famous Stock Picker?
While there are several candidates for best stock picker of the modern era, Warren Buffett is often heralded as the most prominent.
Why Is Stock Picking So Difficult?
Trying to pick stocks is often quite difficult because markets tend to be somewhat efficient, especially over longer time periods. The efficient market hypothesis (EMH) states that market prices reflect all available information, and so there is no way to earn excess returns.