The stock market has been a source of great personal wealth for many people, but some also find it a source of great frustration as well. Even a novice can buy shares of stock to add to their portfolio, but keeping the money safe can be an issue. In this article, we’ll show you how you can pick “winning stocks” for your portfolio. You’ll learn what you need to know to pick winning stocks, so that you can stay on track even in turbulent markets.
As a beginner investor, it is essential to find out about modern trading techniques for picking stocks for long-term holding. There are many ways to pick stocks for long-term holding. One of the best and most successful methods is called technical analysis.
One day I got a call from the teenage son of a former colleague of mine. He wanted to learn more about long-term stock selection strategies. At first glance the question seems simple, but it is very profound.
The challenge was to explain the basics of the stock market to a teenager without making it seem too complicated. So I decided to start with a simple but effective explanation.
You can’t just pick any stock to invest in.
It must have some specific properties. What are these properties? One of the logical characteristics of this action must be that it can produce the expected return.
For example, let’s assume our expected return is 15% per year. Any stock that has the potential to generate a return of 15% or more will be our choice.
What do we mean by equity potential? How do you recognize the potential of a stock? We will learn more about this in the next chapter.
Let me offer you a five-point strategy for long-term stock selection.
How do I know if the stock will make the profit I want?
There is a simple explanation for this. A fundamentally strong stock that trades below its intrinsic value has the potential to generate expected returns. The bigger the discount, the higher the return.
What do we mean by fundamentally strong action?
These are shares whose operations are structured in such a way that earnings per share will increase over time. When EPS increases, the market price of the stock reacts with the same intensity.
What is a discount on intrinsic value?
A stock with a current price of, say, Rs. 85 and an intrinsic value of Rs. 100. This share is trading at a price 15% below its intrinsic value. We also call them undervalued stocks.
#2. Overvalued stocks are dangerous
Beginning investors should be defensive in the stock market. But it’s even more important not to catch a falling knife, like overvalued stocks.
What is an overvalued stock? Shares that trade at inflated prices can be of two types:
- Vulnerability : These are stocks whose underlying business has weak fundamentals. These indicators include declining sales, declining profits, negative working capital, zero free cash flow, etc.
- The demand is great: These are stocks of companies with very strong fundamentals. As a result, their stocks are always in high demand (just like blue chip stocks). Because they are in such high demand, they are often too expensive.
What can we learn from these two points? You should only buy stocks from solid companies. But it is equally important to avoid overvalued stocks.
The problem is that popular market shares often trade at inflated prices. So a beginner may get lost and buy them assuming it’s a good purchase.
So always remember the basic rule: Choose stocks of strong companies that are currently priced low (undervalued).
The rule of thumb is to pick stocks of companies that consistently represent solid business.
How do you quantify a strong company?
Different people may use different measures to confirm the fundamentals of a business. But to explain this to a teenager, I will use the following two parameters:
- #1. Profitability: It is a measure of the profit a company makes for each rupee of its capital. Suppose there are two firms (A and B). They have 100 lakh each to do business. Company A and B make a profit of Rs 15 lakh and Rs 18 lakh respectively. B is a stronger company. How do you do that? With the same capital, company B makes more profit than A.
- #2. Height: The growing company is the darling of investors. No matter how big the company is today, if it grows, it will eventually gain market share. Investors will bet on these companies. They are even willing to pay a premium to buy rising stocks.
A safe strategy for long-term stock selection is to find a solid company. How can I find it? It is a combination of profitability and growth.
An examination of market share provides an indication of a company’s competitive advantage. At this point, we will compare companies in the same industry. That way, you can determine which three companies are the best out of all the others.
How do you do that?
To keep it simple, you can use my Blue Chip Stock Screener. This allows for fair representation. Select a reviewer from the drop-down list, as shown below.
Then select a sector and a subsector (industry) from the drop-down list. See below:
After selecting an industry and an industry pair, a list of all stocks (in that industry) is displayed. The objective is to determine which of these companies has the largest market share. Check their contact information.
One of the numbers in the table is revenue (representing market share). Select the top three companies by revenue.
These three companies are the market leaders in this field/sector. As investors, we would like to buy shares in these companies.
#5. Reference price assessment
The combination of a strong company and a large market share (competitive advantage) creates value.
Intrinsic value is the number that converts a company’s qualitative value proposition into a quantitative number. A more familiar term for intrinsic value is fair value.
Valuation models (e.g. NCAVPS, DCF, etc.) developed by experts are used for conversion. These valuation models quantify the strengths and weaknesses of a company and combine them to estimate its intrinsic value.
How is intrinsic value useful?
An investor can compare the estimated intrinsic value of a company with its share price. If the estimated net asset value is higher than the current price, the stock is undervalued. This is called a potential stock.
It is also true that the application of evaluation models is not easy for newcomers. These people can use my spreadsheet for stock analysis. A spreadsheet can estimate the intrinsic value of a stock by clicking a few buttons. This is an automated process.
The theory is that you only buy shares of solid companies at low prices. To do this, we need to analyze the inventory.
But the practical problem with this theory is that our market consists of over 5,000 numbered stocks. It is impossible to make a fundamental analysis of all shares.
What’s the solution?
The budding entrepreneur should keep these two limitations in mind. First, you can’t buy a stock without analysis. Second, there are about 5,000 numbered shares in the market. You can’t analyze everything.
How do you deal with it? First sift, then analyze. Perform the following two steps:
- #Screen #1: It is impossible to analyze 5,000 stocks. Therefore, we first need to know how to create a shorter list of potential shareholders. The trick is to list only profitable, high-growth stocks. Companies with a high market share in their sector may also be taken into account. Quick tip: View our stock selection.
- #2 Analyze: Once we have a short list of actions, we can begin to analyze them. But how can a neophyte (beginner) analyze stocks? Chances are they know almost nothing about the action. For these people, I recommend reading my series of articles titled Trading Basics. This will pave the way.
A reliable stock selection strategy is to develop your own expertise in value investing. This is a sound investment strategy. What we have discussed in this article is an excerpt from the general theme of value investing. Keep going, you won’t regret the step you’ve taken.
Thank you for reading. Have fun investing.
Frequently Asked Questions
What is the best long term investment strategy?
The best long term investment strategy is to invest in yourself.
What is the best strategy for a beginner investor?
The best strategy for a beginner investor is to invest in a diversified portfolio of stocks, bonds, and other investments.
How do you pick stocks 7 things you should know?
1. Start with a list of companies that interest you 2. Find out the company’s history 3. Find out the company’s financials 4. Find out the company’s current valuation 5. Find out the company’s future prospects 6. Find out the company’s industry 7. Find out the company’s competitors
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