Learning how to pick good stocks, can lead to headaches and anxiety if you’re just getting started. Investment veterans also find themselves making tough decisions but it gets easier with a certain level of experience. Not only that, the amount of capital you have available, and whether you are trying to find the best stock for day trading, or you prefer other styles like swing trading, position trading or investing can all determine how to choose the right stock.
With the popularity of exchange traded funds (ETFs), or the suggestion of Warren Buffet to buy index funds, buying individual stocks seems to be falling out of favor. But for rugged, self-directed investors, it’s still an appreciated route to investment success. However, if you’re new to investing in individual stocks, what are the rules for picking good stocks? As of now your criteria for how to pick good stocks should be accounted as part of a trading plan. If your trading plan is dynamic (like the ones we have listed below), then it will evolve as you continue to learn and uncover your strengths and weaknesses.
How To Pick Good Stocks: 5 Easy Tips
Here are a few things to learn about how to pick good stocks:
Pick The Businesses You Understand
Everyday products and services:
There is what seems to be an endless amount of different companies you can buy stock in today. Some of these well-known companies, selling everyday products and services are the companies you should pick to lay your capital in. There’s a close correlation between the success of a product or service, and the performance of the company stock. And when a product is common, it means it’s well understood and accepted by the consuming public. If you understand the company’s products, and more specifically if you already use them, you have a better understanding of how the company works.
Another stock option includes companies that are engaged in industries where you have a more than average understanding just because you’re employed in the industry, or have been in the past. Or it might be because you have a particular interest in a certain industry, even if you don’t currently use any products and services it produces.
Now when it comes to the flip side, it’s best to avoid those companies you don’t understand. For instance, there are a lot of upstart drug or pharma companies that may be showing considerable promise. With more and more news articles/documentaries coming out we see that many of them are selling the experiment rather than the product. That is, they’re working on an experimental drug that’s expected to make a major medical advance, like in the movie Dallas Buyers Club. But until they actually have a breakthrough, and begin marketing the product, they’re not profitable–they may not even be breaking even or seeing cash come in. This is just one example of an industry or company you may not understand. There are plenty of others, particularly those that involve a high degree of research.
All in all, there may be very practical industries that involve complicated business models.
If you’re having difficulty grasping exactly what it is they’re doing, or how they make money, those stocks are preferred.
Pick The Companies that Dominate their Industries
Have you noticed that the same companies keep coming up in different portfolios? It doesn’t matter if we’re talking about index funds, actively managed mutual funds, or individual portfolios designed by investment managers. Names like Amazon, Starbucks, Apple, McDonald’s, and Facebook seem to sink and rise and keep reaching the surface no matter what. Like we’ve discussed in the point above, these companies do well because people are very well aware of exactly what they do. The reason they are able to dominate their respective industries is because certain companies dominate their respective industries from being the first ones there. With big roots that have already set it place, that makes an investor’s job a lot easier.
Not only do such companies have a strong track record of industry domination, but they have an uncanny knack of coming out with new products and services that are well received by consumers.
There’s a reason why that happens, there is no fluke here. Basically, these companies have the capital, know-how, and energy to turn out winning products and services. There’s never a guarantee they’ll continue doing this going forward. But the fact that they have a track record of doing it consistently in the past is an excellent indication of continued success.
Don’t Put All Your Eggs in Two or Three Sectors
This is virtually a disclaimer on the previous recommendation. Yes, you want to invest in industries that you understand. But at the same time, be sure your portfolio isn’t overloaded with stocks in a very small number of industries.
For example, if you work in IT, you may be tempted to overload your portfolio with tech stocks. After all, that’s your business, your industry, and what you understand. But any industry, no matter how well you know it, is subject to the ups and downs of the market. Just because technology is flying high today, doesn’t mean it will forever. Look back at Nokia, Orkut, Yahoo, etc.
If you plan to hold say, 5 different stocks, make sure they’re diversified across three different industries. The worst thing you could do is have half or more in a single industry. While it might serve you well when that industry is in an upswing, the backlash can be financially punishing when that sector turns down.
Realize that for a host of reasons we cannot predict, a specific industry can go into a bear market, even while the general market is flourishing. It’s all about diversifying the metaphorical eggs you have in your basket and that matters whether you’re in funds or individual stocks.
Dividends represent the return of a portion of a company’s profits to investors. They provide an immediate return on investment, so the investor is not entirely dependent on capital gains. They’re particularly attractive to income investors, and do provide some reliable measure of protection in market downturns.
Not only that, a company that pays dividends to their investors on a consistent basis is a healthy company. They’re able to continue operations, and even expand, while returning some of the profits to their investors.
Dividend aristocrats are described as “companies in the S&P 500 that have increased their payouts every year for at least 25 consecutive years.” The S&P 500, or simply the S&P, is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices, and many consider it to be one of the best representations of the U.S. stock market.
Dividend aristocrats are also referred to as “dividend growth stocks,” which might be the optimal combination. You’ll undoubtedly notice that many of the companies on this list are well-known, and meet other criteria in this article.
Pick Companies with a Solid Track Record
The ultimate stock market fantasy is buying “penny stock” of an obscure, upstart company, then watching its stock price soar past $100 in just a few months.
But fantasy is all that is. Sure, it happens in real life. But it’s only recognized in hindsight, after the stock price has taken off. Rest assured that for every such success story, there are 1,000 would-be fantasies that never got out of the starting gate. For that reason, it’s become very cliche for investment managers to all gather information from the same sources. They go with companies that have a proven track record.
Obviously, this will move you out of the realm of new companies. But the “first rule” of making money in the stock market is not to lose any. Any company that’s relatively new and unproven, is more likely to result in a negative outcome.
To be an established company, the business should be around for several years–the more the better. Even more important, they should have a steady track record of increasing both revenues and profits on a consistent basis. For example, you might look for a company whose revenues and profits have grown in eight of the last 10 years. Steady growth patterns generally show promise. Other investors see that too, as well as fund managers. Chances are, they’re either already holding that stock, or plan to buy it in the near future. All of that bodes well for the long-term prospects of that company.
There is no magical solution on how to pick good stocks as the spell has yet to be conjured. But if you can understand that your best strategies can still produce losses, welcome to the world of investing. Investing requires a large measure of accepting risk, and that is the understanding that comes with markets and stocks rising and falling.
The best any of us can do is to only improve the chances of picking winning stocks and avoiding losses. Please understand that the pointers above will help you create guidelines to govern what stocks to pick and run with. Good luck!