Talk about a can of worms on this one. Stock picking is the holy grail of investing, more life-changing and mind-consuming that wife-picking, career-selection and choosing the next winner at the local track.
The goal is clear: pick winners. The rest quickly becomes must more complicated than this simple goal might imply.
Because what makes a stock a winner is every bit as complex, elusive and mysterious as love and gambling (often synonymous) itself. And if you look at the divorce statistics, you know that even the most careful selection doesn’t always turn out as planned.
The Criteria of Choice
Just as it is with love – a comparison rarely used to illuminate the investment trade, but one that, upon deeper pondering, offers many parallels – stocks come in many sizes, shapes and personalities. The right choice has as much to do with the picker as the chosen one, because it’s as much about the match as it is about the specific security you’re acquiring.
In love and in investing, once chosen you have to live with either. Because getting out can be expensive.
Stock picking is driven by the specific goals and needs of the individual. There is a significant difference between selecting stocks for the short term versus the long term, just as there is a big difference between selecting growth stocks versus income-generating (through dividends) stocks.
The wise investor analyzes their needs long before they analyze which stocks to buy and sell. Because in addition to the inherent upside potential of a given stock, there are other variables that are just as important.
Risk Factors
One of them is the level of risk the investor is willing to assume. All stocks carry the risk of loss, but some are more vulnerable to market swings and investor whims than others. Even when the performance of the underlying company is solid, some stocks swing wildly with the market, while others (mostly high dividend stocks) remain fairly stable in virtually any market.
Staying Liquid
Another variable is liquidity. This isn’t an issue when trading listed stocks, but privately held, off-market securities (such as “angel” investing in new start-ups) may not be liquid, meaning you can’t sell when you need to get your hands on your capital.
One From Column A, One From Column B
With stock picking, and after the investor gets clear on their goals, needs and acceptable level of risk, there are two realms of analysis that comprise the process – fundamental analysis, and technical analysis.
Fundamental analysis considers all factors of the underlying company. This includes its financial strength, profitability, capitalization, and future outlook in light of it’s specific product and position with its niche.
These factors combine to assist analysts in giving stocks a rating, which takes all of these factors into consideration under the application of sophisticated financial modeling tools and programs. Ratings seek to create a level playing field that allows investors to compare the relative strength and potential of a stock in comparison to others, but without having to go through the process of analysis themselves, which would be difficult if not impossible in most cases.
Getting Technical
The other realm is technical analysis. This looks at the price performance of the stock itself over time, establishing trends and relationships to market conditions that create patterns. Analysts again apply sophisticated tools to these patterns in an attempt to predict a stock’s near-term behavior, without regard for what’s going on in the company itself.
An underlying assumption of technical analysis is that it is business as usual at the company, meaning the only things that will affect the stock’s price in the short term are market-specific factors and patterns. If the company should make an unexpected announcement about their performance or future, this would render near-term analysis virtually moot, at least until the initial shock wave impacted the price (which can happen in either direction, depending on the news) and the stock has returned to a normal trading pattern.
So, with all this on the table, how does one go about picking stocks? The answer is as complex as the person asking the question. It depends on what they want out of the process, and what level of risk they are willing to assume to make it happen.
In the Final Analysis
Once those factors are solid, then the tools of fundamental and technical analysis come into play, in combination with the opinion of investment professionals, to help move the decision process forward.
But as it is with love, there are no sure things in the stock market. Which means we need to do our homework, and, depending on how confident we are, trust our instincts. Because we alone must live with our choices, and there are always consequences attached.
