How do you choose a successful investment stock? Owning stocks is like owning small parts in multiple companies and businesses. Since public companies are required to disclose their financial statements and publish their reports periodically, you, as an investor, should begin reading these reports before deciding to purchase any stock.
There is no single right way to choose an investment stock, but there are some basics that can help investors narrow down their search before reading the financial reports of each company on the list.
Here are the four most important steps on the right path to becoming a highly cultured and astute investor who knows how to choose profitable stocks:
1. Determine investment objectives.
The first step in stock selection is determining a portfolio objective. Investors focused on income generation, capital preservation, or capital appreciation will apply different investment criteria to each. Income-focused investors typically choose low-growth companies in industries and sectors such as utilities, while other alternatives, such as REITs and master limited partnerships (MLPs), are readily available. Those with a lower risk tolerance and primarily concerned with capital preservation tend to invest in large, stable companies. Investors seeking capital appreciation target companies with varying market capitalizations and lifecycle stages.
Read also: 4 steps to building a profitable investment portfolio.
2. Selection of companies.
The next step in the stock selection process involves finding companies that interest you. There are three simple ways to find companies:
1. Search for ETFs that track the performance of a specific industry or sector and identify their aggregate holdings. This is very easy to do; simply search for “industry ETF X,” and the ETF’s official page will reveal either all of the fund’s holdings or its top holdings.
2. Use a screener to filter stocks based on specific criteria, such as sector or industry. Screeners provide users with additional features, such as sorting companies based on market capitalization, dividend yield, or other useful investment metrics.
3. Search blogs, stock analysis articles, and financial news releases to gain insights into companies in your chosen investment sector. Remember, read everything critically and analyze it from all angles.
The three methods mentioned above are not the only ways to choose a company, of course, but they are a good starting point.
A company is more than just a set of numbers; it’s a living entity, with new things and changes happening every day, all of which are critical to its performance and future value. Carefully study the company’s basic financial statement : revenues, operating margins, and cash flow. These factors will paint a reasonable picture of the company’s current financial position and its ability to generate profits in the short and long term.
On the revenue side, investors should examine the stability and trend of these revenues. Operating margins measure the efficiency of a company’s operations, so higher operating margins are considered better than lower ones. Reviewing a company’s cash flow figures, particularly cash flow per share, is important because this is useful in measuring profitability and can help assess whether the stock is overvalued or undervalued.
3. Read the company’s annual report.
Suppose you have the annual reports of several companies, how do you read them to get the information you want?
The reports will seem like they’re written in a language you won’t understand at first, so it’s advisable to meet with a financial advisor to give you a quick lesson first. While this may cost you some money, you’ll gain invaluable information in the end.
Reading an annual report is key to determining a company’s value. With time and practice, you’ll learn how to read the numbers and understand what’s going on inside the company. You’ll also begin to understand terms like goodwill, depreciation, and diluted outstanding shares.
Read also: The optimal investment portfolio for rewarding returns.
4. Keeping up with what is happening in the market.
If you want to become an informed investor, you must stay abreast of current market events and opinions. Reading blogs, magazines, and online financial news is one form of passive research you can do daily. Sometimes, a news article or blog post can form the basis for an investment decision.
How do you choose an investment stock from a news article? For example, reading a newspaper article about a major acquisition might prompt you to conduct further research into the fundamentals driving the industry. The internet provides a wealth of information with ease, offering analysis of any major market event from diverse investment experts with multiple perspectives. Sometimes the underlying hypothesis can be as simple as: “There is a trend away from poverty in emerging markets currently, resulting in an increasing number of people moving into the middle class. As a result, there will be an increase in demand for product/commodity X.” This hypothesis can be taken to the next level by the investor concluding that increased demand for product X will lead to a boom in the businesses producing product X.
This type of simple fundamental analysis forms the basis for constructing the general “story” behind an investment, which justifies the purchase of any stock in a given industry. An important research requirement is a careful examination of the assumptions and theories underlying the original hypothesis. For example, if the supply of X is unlimited, then the pressure to increase demand will have only a minimal impact on companies engaged in selling and producing X. After you have conducted this qualitative research and are convinced of the general hypothesis, you can continue your analysis using company press releases and investor presentation reports.
Read also: How to invest long-term in stocks
Conclusion
How to Successfully Choose an Investment Stock With the abundance of information and options available, making an investment decision sometimes more difficult than it makes it easier, therefore, first defining your investment goals and conducting an initial stock screening based on these goals will help you get off to a good start in selecting stocks that will meet your needs. However, remember that these screening steps only narrow down the list of potential investment options and are not a substitute for in-depth fundamental analysis.
To strengthen your investment knowledge, you should read investment and financial books and everything related to stocks and financial statements.
Choosing profitable stocks is extremely difficult, if not impossible, which is why we use portfolios and apply diversification in asset allocation. We base our investment decisions on the financial, administrative, operational, and marketing positions of companies.
