Stock Selection Strategies

Introduction

When it comes to personal finance and the accumulation of wealth, few subjects are more talked about than stocks. It's easy to understand why: the stock market is thrilling. But on this financial rollercoaster ride, we all want to experience the ups without the downs.

In this tutorial, we examine some of the most popular strategies for finding good stocks (or at least avoiding bad ones). In other words, we'll explore the art of stock picking–selecting stocks based on a certain set of criteria, with the aim of achieving a rate of return that is greater than the market's overall average.

Before exploring the vast world of stock selection methodologies, we should address a few misconceptions. Many investors new to the stock-picking scene believe that there is some infallible strategy that, once followed, will guarantee success. There is no foolproof system for picking stocks! If you are reading this tutorial in search of a magic key to unlock instant wealth, we're sorry, but we know of no such key.

This doesn't mean you can't expand your wealth through the stock market. It's just better to think of stock picking as an art rather than a science. There are a few reasons for this:

So many factors affect a company's health that it is nearly impossible to construct a formula that will predict success. It is one thing to assemble data that you can work with, but quite another to determine which numbers are relevant.
A lot of information is intangible and cannot be measured. The quantifiable aspects of a company, such as profits, are easy enough to find. But how do you measure the qualitative factors, such as the company's staff, its competitive advantages, its reputation, and so on? This combination of tangible and intangible aspects makes picking stocks a highly subjective, even intuitive process.
Because of the human (often irrational) element inherent in the forces that move the stock market, stocks do not always do what you anticipate they'll do. Emotions can change quickly and unpredictably. And unfortunately, when confidence turns into fear, the stock market can be a dangerous place.

The bottom line is that there is no one way to pick stocks. Better to think of every stock strategy as nothing more than an application of a theory–a "best guess" of how to invest. And sometimes two seemingly opposed theories can be successful at the same time. Perhaps just as important as considering theory, is determining how well an investment strategy fits your personal outlook, time frame, risk tolerance, and the amount of time you want to devote to investing and picking stocks.

The stock selection strategies discussed here are:

Without further ado, let's start by delving into one of the most basic and crucial aspects of stock picking: Fundamental analysis, whose theory underlies all of the strategies we explore in this tutorial (with the exception of the last section on technical analysis). Although there are many differences between each strategy, they all come down to finding the worth of a company. Keep this in mind as we move forward.