The stock market is full of frills and thrills. Stock market investment, just like any other investment, comes with its ups and downs. However, investors desire the ups without the downs, hence the need for stock-picking strategies. The objective of every investment is to achieve as much returns as possible, taking into consideration a set of selection criteria. In the stock market, investors seek stocks that outperform the general market over a period of time. It is therefore necessary to have a proper strategy in place to select good stocks, while avoiding bad ones that can lead to erosion of investment.
The ultimate strategy
Many investors believe that there is a sure-fire strategy to selecting stocks which if adhered to would by all means guarantee higher returns. This is a misconception, or perhaps, a myth, since so many factors come into play in the performance of a stock. There is, therefore, no definite strategy in selecting stocks. However, knowledge of some of these factors could go a long way in guiding an investor towards making that key decision which will ultimately earn the investor success.
The performance of a stock in the market ordinarily symbolises the health of a company.
Since a lot of factors influence the health of a company, it is almost impossible to design a perfect formula that will predict success. It is one thing to assemble data that you can work with, but quite another to determine which numbers are relevant. A lot of information is intangible and cannot be measured. The quantifiable aspects of a company, such as profits, are easy enough to find. But how do you measure the qualitative factors, such as the company’s staff, its competitive advantages, and its reputation and so on? This combination of tangible and intangible aspects makes picking stocks a highly subjective, even intuitive process.
Also, for reason of the human element inherent in the forces that move the stock market, stocks do not always do what you anticipate they will do. Emotions can change quickly and unpredictably.
Stock-picking can also follow scientific method of thinking, where carefully thought through processes are followed up with testing the validity of such techniques through a procedure known as investment analysis.
Since the stock market follows the random walk hypothesis, there is no clear cut strategy in picking stocks. Rather, you should consider other factors that could help determine your preferred strategy – your personal outlook, time frame, risk tolerance and the amount of time you want to devote to investing and picking stocks.
Fundamental analysis & stock-picking
Most investors are used to hearing the phrase “strong fundamentals” or “weak fundamentals.” What exactly does this phrase mean? Fundamental analysis involves getting a value of a company using fundamental valuation techniques and comparing this value to the price of the stock in the market. At the end of a valuation, a value known as “intrinsic value” is obtained for the stock and where this value is lower than the stock market price then the stock is overvalued and should be sold.
Where the price is higher than the stock market price then the stock is undervalued and is a good buy. Fundamental analysis makes use of various valuation techniques and some of these include Dividend Valuation Model and Analysis of Free Cash Flows. The former is useful for companies that pay dividends while the latter is useful for those companies that do not pay dividends.
Fundamental analysis might appear very technical and bogus to you as a random investor but it is not far from being the most important strategy to be adopted in picking a stock. You might not have the technical know-how to do some of these analyses and so you should consider seeking advice from your financial adviser, investment manager or broker. You might be interested in finding out the going concern of a company; hence you should do some fundamental analysis. Next time you desire to make an investment in a stock, remember to ask the question, “Does the company have strong fundamentals?”
But fundamental analysis involves much more than quantitative analysis in which you obtain a value for a company. It also subsumes some qualitative aspects that impact on the performance of the company in the industry in which it competes.
Muyiwa Olanrewaju is the CEO of Watershed Capital Limited
Email: [email protected]