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How to Pick Stocks for Your Portfolio

How to Pick Stocks for Your Portfolio

As of August 2021, the global stock market boasted a cumulative value of $95 trillion, with this having risen exponentially since the mid-90s.

Of course, the stock market has also diversified as it has continued to grow, creating a much broader range of assets and investment vehicles for traders to consider over time.

There are certainly a huge number of stocks that you can incorporate into your portfolio. But how exactly should you go about selecting these?

Getting Started with Fundamental Analysis

While there’s no single or foolproof way to select stocks for your portfolio, undertaking fundamental and technical analysis at least enables you to determine an equity share’s true market value.

As the name suggests, fundamental analysis refers to an individual stock’s intrinsic value. As a result, your analysis should focus on a number of key qualitative and quantitative measures, which cover company-centric factors and those associated with the wider economy. Here’s a breakdown of the key qualitative aspects:

  • #1. Company News and Events: We all know that macroeconomic factors like interest rates can impact the stock market, but share prices may also be influenced by specific company news and events. In general terms, good news such as a large-scale merger will create a rush to buy company shares, whereas bad news will likely trigger a sell-off. As supply and demand fluctuates, so too does the share price, and it’s important to measure this as part of your analysis.
  • #2. Management Restructuring and Personnel Changes: There’s no doubt that large-scale personnel changes or the complex restructuring of the senior leadership team can be disruptive for a business. This certainly causes uncertainty and changes how the business is perceived by investors, potentially reducing demand and lowering share prices in the process. The key is to determine whether this is temporary and capable of creating value or a much longer-term trend.
  • #3. Financial and Economic Events: On a final note, we should note that economic events and data releases often have a huge impact on share prices. For example, recent interest rate hikes in the UK have been introduced to undercut rampant inflation, but increasing the cost of borrowing and the financial pressure on homeowners is likely to translate into reduced company earnings in the short-term. This has a direct and immediate impact on share valuations.

In contrast, quantitative factors tend to focus on a company’s financial performance, their revenues and the assets (or liabilities) that it owns. Here’s a little more detail to provide some context.

  • #1. Earnings Data: All publicly-traded companies are required to regularly publish earnings data, usually in the form of three quarterly reports for each financial year. Each one will contain revenue information pertaining to the most recent three-month period, along with a direct comparison with the same quarter last year. As an investor, you should definitely track these data releases, as it helps you to gauge a company’s price-to-earnings (P/E) ratio and determine whether or not it is currency under or overvalued.
  • #2. Balance Sheets: A company should also operate a balance sheet, which should provide a comprehensive and detailed list of its assets and liabilities. As an investor, you should ideally look for a positive balance sheet that owns more than it owes, as this should translate into a much steadier and more reliable share price performance. This also reflects future earnings potential, while creating a debt-to-equity (D/E) ratio that measures a firm’s liabilities directly against its assets.
  • #3. Dividends and Profit Management: The term ‘dividends’ refers to the portion of a business’s profit that’s returned to shareholders at the end of the financial year. Dividends also create a vehicle through which shareholders can earn and monetize their equity stake without selling. From a wider investment perspective, dividends are indicative of a company’s innate profitability and likelihood of generating future earnings.

A Look at Technical Analysis

We’ve already touched on technical analysis, which should also form part of the process when selecting stocks.

Technical analysis is focused on a company’s stock price information and movements, including cyclical patterns or trends that may help to identify future shifts.

While there are a number of technical indicators that can be used to underpin such analysis, a few remain considerably more popular than others. These include:

  • #1. The Moving Average: The Moving Average (MA) is commonly used to identify the long-term direction of a particular trend. This indicator makes its calculations without incorporating short-term price spikes, which is ideal for investors with a long-term outlook or classic ‘buy-and-hold’ strategy.
  • #2. The Stochastic Oscillator: This technical indicator highlights momentum and trend strength over a particular period of time, by drawing a direct comparison between a particular closing price of your chosen asset to a wider range of values.
  • #3. Bollinger Bands: Bollinger bands are widely used as part of technical analysis, thanks largely to their ability to forecast long-term price movements. Bollinger bands also help you to recognise when a particular asset is trading outside of its usual range.

The Last Word – Avoiding Emotion and Diversify Your Portfolio Over Time

As you can see, combining fundamental and technical analysis enables you to thoroughly research your stock market options, by comparing a company’s fundamentals and intrinsic value with its long-term price movements and trends.

But are there any other considerations when selecting stocks for your portfolio? Well, it’s crucial that you remove any emotion from your investment decisions, whether you’re buying into hype around a particular stock or drawn to an asset simply because it has recently experienced exponential growth.

Both of these factors mean nothing without the context provided by fundamental and technical analysis, which can help you to examine price trends more closely and make a more informed decision.

On a final note, you should also strive to create a diversified stock portfolio from the outset. The reason for this is simple; as it enables you to immediately minimise your exposure to risk, while ensuring that you incorporate assets in different sectors and with variable market capitalisation values.

To this end, you may also want to consider investing some of your capital in stock market indexes.

After all, this provides natural diversification across different sectors and market cap values, while allowing you to speculate on price movements and profit without owning the underlying stock.

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