How do you pick a winning stock?

Summary

• Identifying winning stocks can involve looking at several factors from sustainable free cash flow to the simple price to earnings ratio and more.
• Prior to picking stocks, an investor must first identify their investment goals, diversification strategy and time horizon and other factors.

Investors are passionately looking ways to find the most suitable option to invest their money. Also, this has become more evident as retail and novice investors also look to benefit from the markets peaking following improved economic activity and mass vaccination drives.

One of the most fundamental ways to do so is by choosing stocks that can be high performers. However, before looking at some of the different ways investors can pick winning stocks includes, there are some factors one should consider:

Investment goals

Prior to picking stocks, an investor should first determine their investment goals. An investor can either have a focus on choosing an income-oriented portfolio, which tends to be from the lot which has low growth but dividend paying and stable companies.

Another investment approach may be for those seeking capital appreciation which includes companies that are in the early growth phase; such stocks can provide high returns but also carry a greater risk associated with them.

An investor can have either of these two or a combination version with a portfolio investment tilted towards a particular investment strategy while also having a diversified portfolio to minimise portfolio risk.

Moreover, having a time horizon for the investment is another factor an investor must consider prior to investing in stocks.

Also Read: 5 FTSE 100 companies with a dividend yield of over 5%

Stock picking methods

Once an investor has identified their investment goals and other related factors such as risk threshold, time horizon and more, they can look at the following ways to identify winning stocks:

• Sustainable free cash flow – Investors can use the sustainable free cash flow measure to arrive at a more effective valuation of a company compared to the oft used price to earnings ratio (P/E). This measure gives an investor of a company steady state free cash flow yield without having to do the full discounted cash flow analysis of a company and can be one of the first few checks of investigating whether a stock is worth looking into deeper.
• Liquidity - Identifying if a stock is highly liquid is a key element for investors, particularly for institutional investors and also private investors. Not being able to liquidate one’s position due to stocks being highly illiquid can add to its risk.
• Supply-side analysis – A company’s capacity growth rate is an important factor to consider as it can be highly variable and strongly impact profitability. Moreover, supply can be forecast to a higher degree of accuracy than demand growth.
• Per employee measures – Using measures on a per employee basis helps identify a company’s productivity trends, acquisition insights and also helps in making cross sector comparisons.
• Price to earnings – The price to earnings ratio is one of the first few ratios an investor can look at to get a sense of how a company is trading. However, the ratio can be easily manipulated and can include write downs or special charges; thus it is not a very accurate measure.
• Price to earnings momentum – This measure shows whether a company has a positive change such as beating estimates, rising volumes and more.
• Price to book – The price to book ratio measure is popular among value investors as it looks at the accounting or book value of a company.
• Historical data – It is also key to look at the historical trends of a measure and identify trends of a company to gain some context of its past performance.
• Technical analysis – The above measures are some of the important ways to do a fundamental analysis of a stock. However, combining technical analysis with fundamental analysis can provide an estimate of how a stock may perform.

The above is just some of the ways an investor can pick winning stocks however, they must do adequate research and leverage online tools such as screeners and other available resources or take experts advice to make the best investment choice suited to their needs.

Also Read: Growth vs Value investing: All you must know about two stock market approaches