Proper stock selection is essential when looking to build wealth. Though there is no set stock selection formula, you may find different approaches that lead to an investor or share trader's success.
Individual factors such as experience level, risk tolerance, time, capital, expected outcome, etc., are crucial when determining a stock-picking strategy.
If you are trying to find out how to pick good stocks in Australia, our guide equips you with the best strategies to find potentially profitable stocks in your chosen market.
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1. What Are The 4 Steps In Picking A Stock?
So, how do you know which stock to choose? Here are the simple steps to learn stock selection:
Step 1: Evaluate The Market
Around 75% of stocks follow the direction of the broader market. So, before you add a position, make sure you look at the market's momentum. Buying stocks when the market is trending higher could boost your chances of a successful trade.
Also, watch out for potentially market-moving events such as earnings announcements, Federal Reserve policy meetings, etc., as they could impact your trade.
Step 2: Identify Sectors That Look Promising
One way to do this is to track the performance of individual sectors to find which have excelled in recent months. Sectors or industries with defensive characteristics, such as Health Care and Utilities, are good options.
Step 3: Narrow Down Your List
Different types of stocks are listed in the market. Some are dividend-paying stocks, while others are growth stocks that give you stock price appreciation over time.
The former is usually available at lower valuations (lower prices compared to current fundamentals), while the latter tends to have higher valuations that show the company's potential.
Once you identify the type of stock, the next step is to use the screener tool to filter the stocks in that category based on:
Price-to-earnings (P/E) ratios
Historical or expected growth rates
Step 4: Perform Fundamentals and Technical Analysis
Having shortlisted a handful of stocks that passes the above parameters, the next step is to check the stock's fundamentals, including:
Red flags, such as a lawsuit against the company or a product recall
Positive indicators such as new product launch or the announcement of a takeover
Next, look at each stock's trend line to find the right time to enter the stock. Based on technical charts assessment, you can buy when the stock is into an uptrend or when at a dip if you believe the fall in stock price is an anomaly.
While you follow the above steps, carefully track your expectations and reasons behind each trade.
2. How Do I Choose Shares On The ASX?
Do you want to start investing but need more proper knowledge about the stock market?
Here are steps-wise instructions to help you understand what stock a beginner should buy:
Step 1: Understand The Type Of Stocks
You can find different types of stocks in the market. The first step in your stock selection strategy is learning the four stock types:
Blue Chip Companies (The S&P/ASX 50)
These are Australia's top 50 well-established and stable companies, ideal for risk-averse investors looking for consistent returns.
Capital Growth or Income
Some stocks offer a regular income in the form of dividends, and others provide capital growth. You need to decide which one aligns with your goals.
Companies that pay regular income are generally larger on the Australian Securities Exchange (ASX). Check their track record of paying high dividends before investing.
Growth-focused companies are smaller companies that are more likely to reinvest profits in the business instead of paying dividends to its investors. Checking their past and projected growth figures could be beneficial before you consider them.
These companies lack a long market history and aren't listed in Australia's top 100 companies. They suit experienced investors who can risk their capital, hoping for more significant returns.
You will find some companies on ASX that operates their business outside Australia. These are less protected than companies regulated by Australian law.
Investing in such companies may be ideal for investors who look for businesses that have yet to reach saturation and offer strong potential for growth and returns.
However, before investing, ensure you understand their business, location, regulation, language, currency, and distance issues.
Step 2: Understand The Market Sectors
The next step to learning how to pick stocks for dummies is to find the right market sector to invest in.
For this, you need to look at the pros and cons of each industry:
Banking and Finance: Companies in this sector usually offer consistent income through high dividends.
Energy and Resources: This is a highly cyclical sector that depends on the condition of the international economy. It comprises mining companies that usually don't give high dividends but has the potential to offer high capital growth.
Consumer: Companies in the Retail segment usually offer medium-sized dividends and fluctuate with the Australian economy.
Healthcare: This defensive segment can get steady returns in any market. As people will always require healthcare services, the sector can give consistent returns regardless of the stock market's overall direction.
Technology: This is the ever-booming sector yet to achieve great heights. You can expect tech stocks to give huge returns in the long term.
International: Overseas stocks listed on ASX expose you to larger markets outside Australia, thereby giving wider diversification. They are highly volatile and have the potential to provide higher returns.
Step 3: Determine Your Goals
Having gained some idea about stocks and sectors, the next step is to choose investments that align with your portfolio's goals – capital appreciation, regular income generation from their investment through dividends and distributions, or capital preservation.
Each of these goals requires a different strategy:
Investors who look for income generation should find stocks with good dividend yields. Their earnings and cash flow should support those dividends.
Investors interested in growth should find budding companies that show promising revenue growth.
If your goal is capital preservation, look for businesses that have been around for decades and yield stable and expectable profits.
Step 4: Find Companies You Understand
You partly own a company when you purchase its stock. If you don't understand the business, you may not hold to the stock in periods of economic downturn. Invest only in companies you know how it makes money, their offerings, and their competitive advantage.
You should trust the management and be confident it will remain in demand in the long run.
Step 5: Do Fundamental Analysis
Determine the company's intrinsic value based on qualitative factors, such as microeconomic and macroeconomic factors.
Carry out economic analysis (GDP, interest rates, and inflation rates), industry analysis (company's market share), and company analysis, including its financial health (debts, cash flows, earnings).
Step 6: Keep Your Eyes Open
Besides analyzing the company and the stock trend, ensure you check the market news, financial news, and opinions of industry experts to stay up-to-date on the following:
The Australian economy
Rates of interest
Industry-specific or regional influences
Relevant overseas economies and markets
Some authentic sources you should refer to include:
The Reserve Bank of Australia's Monetary Policy
Finance and business sections of reputable magazines, newspapers, and websites
Research banks and stockbroker's departments for predictions about economic conditions
Step 7: Follow Big Fund Houses Positions
Big investors only invest when they see strong potential in a stock. Figure out what reputed fund managers are bullish on.
Due to their expertise in stock picking, markets sometimes respond favourably when they take a "buy" position on a specific stock.
Step 8: Insider Trading
Insider trading activity is a reliable indicator of the stock's upcoming bullish or bearish sentiment. It is because company insiders know more about a business's prospects than the general public and are legally obliged to disclose their trades.
3. How To Choose Stocks For Trading?
To know how to pick stocks for day trading, follow these steps:
Step 1: Develop a good understanding of the stock market
Step 2: Research stocks based on the outcome you are trying to achieve, the time and capital you can invest, and your attitude to risk.
Step 3: Perform fundamental analysis to estimate the intrinsic value of a stock. Use a mix of Qualitative and Quantitative stock analysis to build your portfolio.
Qualitative Factors Include:
Quantitative Factors Include:
Step 4: Carry out technical stock analysis by looking at the patterns and trends that hint at future market movements. Technical strategies you can choose based on your trading style are:
Exponential moving average
Moving average convergence divergence
Relative strength index
Average directional index
You can determine whether the stock is overvalued or undervalued with fundamental and technical analysis.
Step 5: The next step in-stock selection for trading is to have a trading plan that aligns with your investment goal. Your stock selection differs based on your chosen trading setup, such as Swing trading, Buy Today Sell Tomorrow, position trading, day trading, etc.
Step 6: As stock investment carries general market and exchange rate risks, pick stocks that suit your risk management strategy. Diversify your portfolio to spread your risk.
Step 7: The stock price is another crucial concern when choosing a stock for trading. Work on the capital you are willing to risk per trade based on your trading strategy, the extent of market exposure, and the risk-reward ratio you have set for yourself.
Based on your investment capital, you can decide on the number of stocks you can buy.
Step 8: When considering overseas stocks, hedging opportunities can help against risks such as outdated business models, the arrival of new competitors, bad decisions by management, etc.
4. How Many Stocks Should I Buy As A Beginner?
There is no single answer to this question as the number of stocks a novice should buy depends on several individual factors such as:
The amount of money you have to invest
The commission you will have to pay for a stock. It is inversely proportional to the percentage of your investment. In other words, the more stocks you buy, the smaller the commission will be.
The price of the stock
Your risk tolerance power. Do you know what the riskiest thing to invest in is? It is putting all your money into a single stock. That's where diversification across sectors is essential.
A beginner investor should buy at least 10 to 15 stocks with fantastic growth potential and can outperform the market.
5. How To Pick Stocks For Long-Term?
To predict what stocks will do well in the future, look for their value. Find stocks that are priced too low for their value. It indicates that they could gain over time.
Identify companies with long-term staying power, like dividend aristocrats.
Thirdly, look at the company's profit margins and long-term earnings.
Ensure that the company has made good choices in the past, is adaptable to market changes, and survived economic downturns.
Make sure the prospects of the industries in which your chosen companies operate are progressing and staying strong.
Lastly, look at the quality of the company's management and its record of investment returns and leadership value. Go with a company with a management team capable of making solid strategic decisions to influence its future direction toward profitability.
A company that meets the above criteria will likely be around for longer.
6. How To Pick Good Stocks For Short-Term?
It would help if you considered reading stock charts and trends to buy individual stocks for the short term. It lets you know the historical performance of the share, its short-term performance, and emerging trends.
With this information, you can find out which stocks are performing well and could give a breakout soon. Though it is not a sure-shot way to predict the short-term trend in the market, you can get an idea of how the stock is likely to perform in the short period.
7. Which Stock Has The Lowest Risk?
To find the lowest-risk stock, you need to check the stock's Beta. It indicates the volatility of the stock against the volatility of the S&P 500.
Usually, stocks with a beta above "1" are highly risky. Such stocks are growth stocks that have outperformed the S&P 500 and could offer higher returns quickly.
If you intend to buy a low-risk stock, make sure its Beta is less than and close to 1. Such stocks are more stable and have given returns in line with S&P 500 performance.
Don't go for stocks with a very low beta, as such stocks have underperformed the S&P 500. Though your chances of losing money due to market volatility are less, their low money-making potential doesn't make them worth adding to your portfolio.
8. Which Stock Will Grow In the Future?
Almost every investor wants to know which stock is most profitable in the market. To find such stocks, you must research companies to learn about their business, operating sector, and management's track record.
Learning the company's basics help you get an idea of whether the business has staying power and can offer returns. For example, a company that manufactures products and services that most people buy is likely to be in demand in the long run.
Furthermore, consider different aspects of the company's governance and prefer companies that focus on environmental safety, worker protection, and other social welfare activities.
9. What Are The Safest Stocks?
Most investors perceive a safe stock as not losing its value under market conditions. Considering the volatile share market, finding a 'safe' share or investment in the share market is not possible.
In times of inflation or any other economic calamity, you can position your ASX portfolio accordingly to reduce your losses.
Investing in exchange-traded funds (ETF's) could be a safer bet if you are a beginner and can't deal with a fluctuating portfolio value.
Alternatively, look for stocks of companies that are highly resilient toward inflation. These include:
Companies with adequate pricing power to increase their revenues in line with the inflation rate
Companies that dominate their markets
Companies should have real and tangible assets to support their cash flow.
Some of the best examples could be:
A2 Milk Company Ltd (ASX: A2M) - with its premium dairy products.
The Transurban Group (ASX: TCL) - owns and operates a range of toll roads.
Sydney Airport Holdings Pty Ltd (ASX: SYD)
AGL Energy Limited (ASX: AGL)
10. What Are The Top 5 Highest Stocks?
Do you want to know what are the best stocks to buy now? Below are the five highly regarded ASX-listed shares you can consider buying:
Commonwealth Bank of Australia (ASX: CBA)
Westpac Banking Corp (ASX: WBC)
BHP Billiton Limited (ASX: BHP)
CSL Limited (ASX: CSL)
Wesfarmers Ltd (ASX: WES)
Their diverse asset holdings make them much safer than other exchange shares.
Buying the right shares can help you grow your wealth. Like any investment, consider the risks involved before investing.
Define clear financial goals and strategy, diversify across different sectors, and adjust your portfolio according to the economic and market situation to get the best outcome.
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