The Steps You Need to Follow for Successful Stock Selection
The abundance of information makes investment decisions in stocks a pretty difficult task. That is why identifying the trustworthy sources is among the first things you should do. To facilitate the sorting and screening of the diverse information, several steps would help arriving at a shortlist of data worth delving into in detail.
The overall theme has to be guiding you when searching through information. The former can belong to an industry that has compelling growth drivers but is not currently favored by the market. Investors sometimes look for an industry which has promising growth prospects in the long-term. After this broad choice is made, you can start narrowing down your search.
The second stage in dealing with the data should be the reduction in the vast amounts of stocks to a size conforming to your needs. For measuring company size, its market capitalization is calculated, as the number of outstanding shares is multiplied by the current stock price. According to outstanding stock value, companies range from micro and small ones to mid-sized and large capitalization ones. The largest companies are universally known, examples of them including: Apple, Exxon Mobil, Microsoft, Google, etc.
The shortlist of companies obtained on the basis of their market cap enables the reviewing of their characteristics, especially of growth prospects. With startup companies or industries, the general expectations of investors are for high growth in sales and earnings. For mature companies, slower steady growth is anticipated. Growth is crucial for dividend payments: for younger companies or high-growth ones, free cash flows are typically reinvested, whereas for more mature companies cash flow can be used to pay dividends above the average level.
The other area where focus should be laid is the specific company’s financial position, which is estimated by financial ratios comprising liquidity, debt and profitability ratios. Liquidity ratios indicate the company‘s position and the proportion between short-term assets and short-term liabilities; the former also shows to what extent the company is capable of covering short-term obligations, such as working capital. Debt ratios show the company’s capability of servicing its obligations. The former are indicative of the size of its debt compared to its equity or assets. By studying profitability ratios, information is obtained on returns on assets, money amounts invested or the equity held.
In the third stage, where data screening is implemented, professional software packages are typically used. Another way of screening the information is by using dedicated brokerage firms and relevant public websites. Prior to the start of the process, investors should have determined their investment goals, where the stress should be especially on the time span, the tax related implications and the risk tolerance.
Even after the screening, the number of companies meeting the criteria may still be too large, so scaling down the information would help. For the purpose, investors should scrutinize the companies on the list, whether their industry provides a comfort level, or using personal considerations.
When the list has been sufficiently narrowed down, you need to make serious in-depth fundamental analysis, with the aid of publicly available information on the specific company, including information from the Securities and Exchange Commission. At this stage, Reuters and Bloomberg can be very useful, though it is pretty expensive service. The company site also contains information you need to know before making the final investment decision.
