How to choose stock

Below, you will find a few tips on how to pick stock you buy if you don’t have an endless amount of time an energy to pour into stock trading.

Stock picking is a comlex subject and there are a lot of different factors to take into consideration. The suggestions below are therefore only to be seen as tools – useful in some situations and unsuitable in others. By filling your ”stock picking tool box” with many different tools, you can increase your chance of becoming a successful stock picker with thriving investment portfolios.

1.) Look for positive price momentum

Researching all exchange- and OTC-traded companies in the world would be a daunting task. We need to narrow down the field, and one way of doing this is to look at the New 52-week Highs, a list found in most financial papers.

It is easy to fall into a trap thinking ”if they are already on this list, it is too late to buy”. However, if you have fairly limited time, skills and energy to devote to stock picking, finding companies right before their share price starts to sore will be difficult. It is easier to buy shares that already display a strong positive price momentum and hope for them to continue upwards. Sure, you would have made more money if you bought for $20 and sold for $100, but buying for $75 and selling for $100 still gives you profit.

One advantage with the New 52-week Highs is that this list is compiled automatically, based on actual price movements caused by actual purchases. It is not a list that an individual analyst put together about what to buy, it is not a list of shares that will yield your stock broker a especially nice commission, it is not a list of companies that have paid to be promoted in a newsletter, and so on.

I’m not advocating that you should go out and buy any stock on the New 52-week Highs with reckless abandon. Personally, I use the list as a starting point and carry out more research before I make any purchase decision. A personal favorite of mine is to pick out stocks from the New 52-week Highs that are making new all time highs.

Important: New issues sometimes enter the New 52-week Highs list not because they are strong but because they do not have much trading history. That is one of the reasons why looking at historical price charts before you make any purchase decision is such a good idea. See tip #2 on this page for more reasons.

Beware of mergers and buyouts

When stock companies are involved in real or rumored mergers, takeovers and buyouts, it can impact the share price. This is one-time events that can push a share into the New 52-week Highs list without really saying anything about the long-term earning potential of the company. If you are into long-term investing and isn’t just trying to make a quick buck during the turbulence, I suggest you stay clear of companies that you know or suspect is on the New 52-week Highs list due to real or rumored mergers, takeovers och buyouts.

When you look at the historical share price chart for a company, watch out for a sudden major one-day spike. It is not unusual for the share price to go through a 20% to 100% increase in share price when it is in the midst of a merger, buyout or takeover situation. After this spike, you can expect a relatively stable price pattern.

2.) Look at the chart for the last few years

When I research a company that I might be willing to invest in, I always take a look at the share price chart for the last few years, with special attention on the last two years. It’s an easy way to get a graspable idea of how volatile the stock has been in the past. Personally, I tend to shy away from stocks with high week-to-week volatility. My investment portfolio is geared more towards stocks with historically stable trends, and the charts help me find these stocks.

3.) Look at earnings growth

When you have a selection of interesting stocks lined up, one way of narrowing it down can be to take a closer look at the ones that reported the highest rates of earnings growth. A high earnings growth can indicate that the company has a competitive edge in its market.

4.) Stay away from penny stocks

Yes, it is absolutely possible to make good money trading in penny stocks. However, successful penny stock investors tend to be very active traders, always ready to sell at the blink of an eye when they smell an imminent drop in share price. Will you be able to do that?

If you don’t want to devote a lot of time and energy into stock trading, and are more interested in long-term and mid-term investments than day trading, I suggest you stay away from penny stocks. Alternatively, do buy penny stocks, but only with a very small amount of your bankroll. See the penny stocks as a fun diversion – just like you would enjoy a roller coaster at the funfair but rather not use it for your daily commute.

Personally, I don’t just avoid the penny stocks I avoid the low-priced dollar stocks as well. Generally speaking, I don’t devote any time into researching stocks where the share price i below 10 USD. That’s because I want to stay away from volatile stocks and as a rule of thumb, stocks priced below 10 USD tend to be more volatile than higher-priced stocks. Of course there are exceptions, but my rule saves me time and effort since I don’t waste time and energy sifting through endless amounts of volatile stocks just to find that one $2 nugget with low volatility and excellent prospects for the future. For others, this type of sifting is what makes stock investing fun. To each their own.

5.) Diversify your diversification

It’s quite common for novice investors to diversify their investment portfolio (why diversify?) simply by buying stocks in a few different companies. When picking stocks for your portfolio, it is better to strive for an even higher level of diversification.

Examples of choices that can provide your portfolio with a more complex diversification profile:

  • Diversify geographically, both when it comes to where the companies are based and which their major markets are.
  • Diversify between industry groups.
  • Diversify between cyclical stock and non-cyclical stock.Have some stocks that you believe will do okay regardless of the economy, some that are likely to thrive during booms and some that are likely to benefit from economic stagnation or downturns.
  • Diversify between mature markets and emerging markets.
  • Diversify between well-established companies and newer additions.
  • Diversify between stocks with a well-established history of dividend payments and stocks without such a history.

You can also diversify your total investment profile by not limiting it to stocks.