Refine your list of stocks
Once have decided how you want to balance your stock portfolio in terms of business sectors and classes of stock, it is time to start picking potential stocks that you want to include in your portfolio.
You do not need to keep to 15 stocks at this stage – feel free to pick as many as you would like, because in this lesson we will show you how to refine your list – you can of course pick and refine your list as you go along at the same time. We will show you how to do a more detailed analysis in order pick a selection of stocks suitable for the portfolio you want to build.
If, for example, you have decided that you want to have at least one large-cap, utility company in your portfolio, you now have to look at a range of utility stocks and decide which you think has the best long-term prospects.
There are a number of ways that you can compare one stock with each other. Fortunately, this is most straightforward when they are in the same sector as each other.
The following checklist will help you work through the process:
A company's historical share-price performance can help you predict how much the value of its shares might rise or fall in the future. This is also true of sectors overall.
- Look at how the overall sector has performed over the past 12 months to 5 years compared with the stock market. Ideally it will have at least matched the growth of the index and preferably outperformed it.
- Now examine how the share price of the specific utility stock you are interested in has performed over the past 12 months to 5 years and compare it to other stocks in that sector. Ideally it will have experienced a bigger than average increase but with as little volatility as possible.
A company's dividends payments can compensate you for the slower price growth of less risky companies, so this is very important to you. Again, use the past to predict the future.
- Look at the company's dividend payouts over the past 12 months to 5 years and compare them with other companies in the sector.
- Look out for any increases or decreases in the size of dividends paid. You want to choose a company whose dividends are stable or growing in size.
Professional analysts are a useful resource for the individual investor – they have the time and expertise to study companies in probably greater depth than you can.
- Look at analyst buy/sell recommendations and make sure you read any accompanying commentary to better understand the analyst's rationale. Even if you choose not to follow the recommendation it might improve your insight into the company and sector.
A company's quarterly or annual financial statement is an excellent resource for you – it will help you build a more intimate picture of a company's strength, performance and management.
- Examine key ratios – for example price to earnings or debt to equity – of the company you are interested in and compare them with companies in the same sector. Re-read the company valuation module for a detailed breakdown of which numbers are optimal for each.
- Look at the company's cash flow – you want this to be big, stable and growing.
- Look at the company's debt – you want a company that can comfortably afford to pay its borrowing costs and which has used any money that it has borrowed to generate higher sales and earnings.
- Look at the company's own forecasts – you want a company that expects solid sales and earnings growth.
- Look at the company's strategy – you want a company that has solid plans for the future and has concrete ideas about how to improve its growth, efficiency and performance.
Technical analysis can help you identify historical patterns in a company's share price and use them to compare it with others and predict future moves.
- Look for key patterns – for example trends, reversals, volatility – that have formed in a company's stock over the past 12 months to 5 years.
- Look for key price levels – are there any resistance levels that a share price has struggled to break above? These might suggest an upper limit for the value of your investment so should be as high as possible.
A free, online stock screener will allow you to compare companies in an entire sector at the click of a button, using a mix of fundamental and technical criteria that you can tailor to your suit your own investment goals.
One example of a free stock screener is YCharts, that is available for English speaking countries. Alternatively, you can simple enter "free stock screener" into Google.com.
- Use this to look at how undervalued or overvalued the company you are interested in is compared to others in the sector.
- Use it to identify companies whose share price has the kind of growth and steady upward trend that meets your investment target.
News coverage can help you stay abreast of a company's performance, plans and any negative developments that could hurt its share price.
- Read the financial press daily and set up email alerts to receive any news about the company you are interested in as soon as it is released.
- Do an internet news search on the company you are interested in, searching back as far as five years. An indepth interview with a CEO, for example, can be useful even if it is old – you can check how well the company has achieved its goals since then.
Remember it's subjective
Following each of the above steps should help you filter out the companies in a sector that are likely to perform best and that will satisfy your risk appetite.
Remember though that stock picking is subjective and there is no 'one size fits all' method that will ensure you make the right choice.
Even a computerised stock screener will rely on you to tell it which criteria to apply. And whether you place more importance on, for example, a company's price to earnings or its debt to equity ratio, is a personal choice that may also change over time.
In this lesson you have learned that ...
- ... once you have decided how you want to balance your portfolio in terms of business sectors and classes of stock you need to do more detailed analysis.
- ... if, for example, you have decided that you need to own shares in at least one utility company, you now have to look at a range of utility stocks and decide which you think has the best long-term prospects.
- ... find a company whose share price has outperformed those of its peers over the past 12 months to 5 years.
- ... find a company that has paid good, regular dividends over the past 12 months to 5 years, and hopefully one whose dividends are growing.
- ... find a company that analysts recommend.
- ... examine financial reports to find a company with good health, performance and valuation ratios and which has solid plans for future growth.
- ... use technical analysis to find a company whose share price has historically moved in a stable upward trend with high upper resistance levels.
- ... use a stock screener to find a company that is currently undervalued and which is likely to achieve your investment target.
- ... follow news coverage so that you are alert to any changes in the company's performance or strategy.
- ... remember that stock picking for a portfolio is subjective at every stage and there is no 'one size fits all' method for success.