We have now built a comprehensive understanding of financial statements and related metrics. Using fundamental analysis to pick stocks is the basis for our ultimate goal: using fundamental analysis to pick stocks. Remember that we previously discussed investable grade attributes? These attributes are a list of criteria to satisfy before investing in a particular stock. Companies with the most items ticked off the list are the ideal ones for investment.
In contrast to my opinion, another investor might not see corporate governance as a significant factor. They may disregard it and say, ‘It’s fine if the numbers tally; I’m happy to invest in this company regardless of other aspects.’
The main thing to remember is that there isn’t any one-size-fits-all approach. Every investor has to create a checklist kept in line with their investment experience. The aim should be to ensure each item on the list is chosen wisely and logically.
Before we can generate a checklist, we must first select an attractive stock. Then, using the criteria of the checklist, we can ascertain if it’s suitable for investing in. If so, then we will invest – and continue searching for other options.
Choosing stocks is always a hard first step. To make things easier, various ways exist to generate a list of stocks worth researching more closely. These methods could include reviewing stock market news and reports, studying analyst recommendations, or evaluating company financials.
- How to pick stocks with general observation – Believing it may sound straightforward, this really is one of the better ways to come up with stock picks. All that is required is to be attentive and observe current economic trends. Observing what people are buying and selling, which products are in demand, and observing discussions in the neighbourhood can all help. Investor Peter Lynch has described this technique in his book “One up on Wall Street”.
- Screening the stocks – A stock screener can prove to be a valuable tool for investors seeking to analyse stocks. With a stock screener, one can filter stocks based on various criteria; for example, an ROE or Return on equity of 25% and a PAT or Profit After Tax margin of 20%. It allows you to quickly narrow down your list of potential investments from among a large pool of stocks. While there are many available options out there, I prefer the stock screener from Google Finance and Screener.in.
- Keeping track of macro trends – Keeping track of the overall macroeconomic trend is an excellent way to spot potential stocks. For example, investments in infrastructure projects in India are evidently on the rise. This spells good news for Indian cement companies.
- Sectoral Trends – It is important to take a sector-specific approach when looking into the latest developments. For example, the non-alcoholic beverage market is traditionally focused on three main products – coffee, tea, and packaged water. However, there is a shift in consumer preferences towards energy drinks. This may present an opportunity for investors to identify companies within this sector that are best-positioned to capitalise on it.
- Special Situation – This is a slightly difficult way of generating a stock idea. One has to follow companies, company-related news, company events etc., to generate an idea based on a special situation. My colleague was able to identify a special situation in Cox & Kings Limited, when the company announced that Mr Keki Mistry (from HDFC Bank) had joined its advisory board. Being considered one of the most transparent and efficient business professionals in corporate India, my colleague felt that this would benefit the stock significantly. After conducting further research, he decided to invest, and it has paid off tremendously with a return of over 200%.
- Circle of Competence – Circle of Competence is an invaluable method for beginner investors to utilise their professional skills in selecting stocks. If you work in the medical field, then capitalising on that knowledge base will pay off when it comes to analysing firms in the healthcare industry. Similarly, those working as bankers have insight into banking and can use it to pick investments. Thus, be sure to capitalise on your innate competence circle when finding stocks.
The source of exploring stocks can come from any direction. Whenever you find one that piques your interest, add it to your list for future reference. This will ultimately become your ‘watch list’.
Remember, that a stock might not satisfy the criteria at a certain point in time, but as the business landscape changes, it could eventually align. Therefore, review any stocks on your watch list regularly.