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Learn to Earn - Peter Lynch

5 Basic Methods Of Stock Picking

Starting with the most ridiculous and the most enlightened:

 

1. Darts is the lowest form of stock picking method. It is a Random selection, wherein you pick the stock on an absolute random basis based on no criteria at all. If you are so clueless, it is better to invest in mutual funds.

 

2. Hot tips- The second lowest form. This method is based on hunch. In this, someone else tells you to buy a particular stock. You buy out of, for the fear of losing out profit. But you never really lose out if you don't buy. You lose out if the stock goes down. 

 

3. Educated tips- Professional Experts who have the expertise and have done their homework. (It is not based on hunch like hot tips). But the problem is that, when the expert changes his mind you have no way of finding out. You will be holding onto the stock because you think the expert likes it, long after he stopped liking it.

 

4. Broker’s buy list- Stock brokers who provide “full service” have their own recommendations which usually come from analysts who are well trained to understand the affairs of the company.

 

The brokers collect ‘buy’ signals from the analyst which are usually divided into categories: - like stocks for conservative investors, aggressive investors, stocks that pay dividends etc.

 

One can build an excellent portfolio by turning stocks from the buy list, that is you put your own brains over the brokers research and get the best stocks.

 

One big advantage over the brokerage firm over educated tips is that, when the broker changes their mind and moves a stock from ‘buy’ to ‘sell’, the broker will inform you of this fact. 

 

5. Doing your own research: It is the highest form of Stock picking. You choose a company after you've done your research inside out.

 

 

The more you learn about investing in companies, the less you have to rely on other people's opinions, and the better you can evaluate other people's tips. You can decide for yourself what stocks to buy and when to buy them.

 

We need two kinds of information:

a. Studying the numbers and the fundamentals


b. General observance in studying by walking into the store and keeping your eyes open. For example walking into a McDonald's and seeing for yourself about the management of the store, employees, crowd, operations etc. These are important clues that can lead you to the right stocks.

 

Earnings, sales, debt, dividend, price of the stock: These are some of the key numbers stock pickers must follow. It is important to know how to decipher the balance sheet.

 

It’s impossible to keep up with thousands of stocks traded on major exchanges.

 

That's why stock pickers are forced to cut down on their options by specializing in one company or another. They could specialize in:

  • Company that have a habit of raising dividend
  • Companies that grow 20% a year
  • Turnaround companies
  • Particular industries etc. 

An investor has to make an educated guess about the future and not blind ones. Your job is to pick good stock and not pay too much for them.

Twelve baggers: Don’t confuse the price of a stock with its story, if the story is good the stock will gain Momentum in spite of odds and that will be your twelfth Bagger.

 

What a company does with its earnings is as important as the earning itself!!

 

  1. Plow back into the business- Reinvesting in the profitable business is best for shareholders.  This  creates greater wealth for shareholders in the long term than any other method.
  2. Waste money on corporate jets, double salaries of employees etc. Nothing in it for shareholders.
  3. Buy back its own shares –With fewer shares in the market, the remaining shares become more expensive. Very good for stockholders.
  4. Pay Dividend-Added source of income to Shareholders but avoids the company and shareholders from possible growth and reinvestment.

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Etee Bajaj

This document is curated by Etee Bajaj. A BBA (HNRS) Graduate from St. Xaviers College, she has also completed her M.Sc.(Finance) and CFA from ICFAI University, Hyderabad. She takes keen interest in stock markets and believes in Value Investing and Fundamental research and considers the storyline of a company a crucial factor in investment. Reading autobiographies of renowned people is her hobby.