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November 20, 2007
Stock Picking
Stock Picking Tips & Strategies

The first stock picking tip is the need to understand fundamental analysis. This type of stock analysis looks at key ratios of a company to determine its financial health thus providing some idea as to the value of that company’s stock. This stock picking strategy is used in combination with other strategies or can be used alone for evaluation of stock. Another stock picking tip includes choosing stocks with reasonable share prices.  You can do this by utilizing the price to earnings ratio.  The formula used to attain this ratio is the recent share price divided by the last 12 months earnings per share. This technique is useful because it can predict shares with strong earnings growth.

Perhaps the most important and commonly noted stock picking tip is portfolio diversification.  This is by far your best protection again risk.  Investing in multiple investment options instead of choosing to place all of your investments in only one area will serve you very well. Thus you should avoid investing more than 20% of your funds into any one industry.

Human emotion and how to control it is also very important when participating in stock picking.  Stocks do not always do what you anticipate and emotions can change unpredictably and quickly. Fear and greed is what keeps most investors from making profits in the markets and tends to happen once confidence is lost. To prevent this it is imperative that you develop a trading plan and you do your research.  Due diligence is key to stock picking.

Some investors advise that when participating in stock picking, investors should stay away from cheap stocks. Cheap stocks are indicated by a low price to sales ratio. Typically good investors do not jump on cheap stocks, but they take the time to recognize what the fair price for a specific stock is. These investors do not rush into overpaying for stocks either. Good investors look at the company and other factors when determining the price rather than simply jumping on cheap stocks.

Successful stock picking means that you obviously want to pick those stocks that are also profitable. It is stated quite simply that profits drive share prices. How companies drive growth is also important in that you want to choose a company that does not borrow or sell more shares, but rather finances growth from profits.  A company cannot fund growth more than its return on equity, so look for companies that have at least 15% return on equity. Most investors will look for at least a 15% expected earnings growth, and more.  The earnings estimates will assist you with this as well. It is a projected, “educated guess” at the upcoming performance of a particular company. When coupled with a company’s past earnings, earnings estimates can have a certain amount of credibility since barring any unforeseen circumstances, a company will tend to maintain its existing trend.

Successful stock picking also means that your stocks should offer a total return higher than the 10% historical market average. A stock with an 11% earnings growth and a 2% yield could potentially provide a 13% annual total return. (To estimate the potential return you would add the dividend yield to the projected earnings growth rate).  Keep in mind that high growth stocks are typically overpriced and have a harder time meeting investor expectations. Basically, this means that stocks with moderately above average growth rates are the best pick when picking stocks.

There is no one “best” or “right” way to pick stocks. Stock picking can be called a form of art, but has also been referred to as a science. No matter what you call it, the facts remain the same. Understanding the stock market basics, sticking to your strategy and doing your research are imperative to successful trading.  All that you can do is apply what you have learned, theories, strategies, techniques, etc.  You must do this by following the stock trading plan that you have developed and you must stick to it.  Don’t let greed and fear motivate your actions and diversify your stock portfolio.

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