Stock Picks
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[edit] Stock Picks Wiki
Stock picking requires an investment not only in money but also in time. In fact, famed investor Warren Buffett suggests buying index funds if your goal is not to actively manage your portfolio for significantly higher than market returns. If you are not willing to devote the effort required to be a successful stock picker, stop reading this page now.
However, the reason why you are here is that you strive to be above average.
To be successful in picking winning stocks, you need to make an informed choice by researching three important aspects in stock analysis: fundamental analysis, technical analysis and qualitative analysis. It should be these three factors that drive your stock picking decisions.
[edit] Fundamental Analysis
In fundamental analysis, you are looking to evaluate the intrinsic value of a prospective company. Is the company's growth, dividends, future earnings appropriately reflected in the stock price? To find this intrinsic value, you need to review the company's balance sheet, income statement and cash flow statement and compare the findings to its peers.
A multitude of information can be extracted from looking at these financial reports.
[edit] Profitability Ratios
- Earnings per share
- Return on equity
- Profit margin
- Operating margin
[edit] Liquidity Ratios
- Current ratio
- Quick ratio
- Cash ratio
[edit] Solvency ratios
- Debt-Equity Ratio
- Long-Term Debt to Total Capitalization Ratio
[edit] Valuation ratios
- Price/Earnings
- Price/Earnings Growth
- Price/Sales
- Price/Cash Flow
- Price/Book Value
By analyzing these ratios and many more, you will gain a better understanding of the company's value devoid of market noise which is different from technical analysis.
[edit] Technical Analysis
In technical analysis, the goal is to study the supply and demand of a security to predict its future price. Technical analysts will study trends, patterns, moving averages and momentum in charts to confirm buying and selling stock decisions. Below is a brief introduction to these concepts.
[edit] Trend lines
Trend lines are established by the supply and demand of a stock at a particular price. If there are consecutive days of increased demand which is reflected in the elevation of the stock price, this is an uptrend. Conversely, if there are consecutive days of increased supply which is reflected in the lowering of the stock price, this is a downtrend.
[edit] Patterns
Given a specific time scale, patterns emerge which can indicate future price directions.
Breakout patterns
- Ascending triangle (breaks resistance level)
- Descending triangle (breaks support level)
Trend reversal patterns
- Head and shoulders (downtrend)
- Inverted head and shoulders (uptrend)
Buy/Sell opportunities
- Double/triple top (profit taking opportunity)
- Double/triple bottom (buying opportunity)
[edit] Moving averages
Fluctuations in price charts are smoothed out when calculating moving averages to identify support and resistance levels of a stock. The stock price is averaged out over a period of days.
Types of moving averages
- Simple Moving Average (SMA)
- Exponential Moving Average (EMA)
- Weighted Moving Average (WMA)
Both the EMA and WMA give more weight to the most recent price changes than the SMA.
If the stock is trading above its 200-day moving average, this can be considered the support level. If it is trading below its 200-day moving average, this can be considered the resistance level.
Moving averages with different time spans are often used in pairs to signal buying/selling opportunities. Chartists look for cross-over points with rounded bottoms or tops. In a rounded bottom, the shorter moving day average crosses over the top of a longer moving day average. This is a buy signal. With a rounded top, the shorter moving day average crosses underneath the longer moving day average. This is sell signal.
[edit] Momentum Indicator
While moving averages help determine the support/resistance level of the market and thus the trend, momentum measures the strength of the trend.
The momentum indicator is a simple calculation of today's close stock price minus its close X days ago. The difference is plotted on a graph centered at 0.
If the difference is 0, then there is no price change. If the difference is positive, today's price is higher than it was X days ago. If the difference is negative, today's price is lower than it was X days ago.
Again, we are looking at cross-over points on this graph to signal buy/sell opportunities. When the momentum indicator crosses above 0, it is a buying opportunity. When it crosses under 0, it is time to sell.
[edit] Rate of Change Indicator
Closely related to the momentum indicator is the rate of change indicator. This is a ratio calculated by today's closing stock price divided by its close X days ago.
This rate of change graph is often accompanied by the price chart to determine momentum strength.
When stock demand is high, the price increases and the rate of change picks up speed. This is positive divergence and the trend signal is strong. However, when the stock price reaches a new high, the pace slows down. This is negative divergence and the trend signal is weak.
Other momentum indicators
- Relative Strength Index
- Stochastic Oscillator
- Moving Average Convergence Divergence
[edit] Qualitative Analysis
Combined with fundamental analysis, technical analysis can be a great tool to determine when to enter or exit a position of a particular stock. However, as famed mutual fund investor Peter Lynch once said, “Go for a business that any idiot can run - because sooner or later, any idiot probably is going to run it.”
As retail investors, the chance to gain an audience with big business CEOs is pretty slim. However, we still want to know how responsible a company is in handling our investment dollars. Read the annual reports to understand where the company is headed and backtrack to previous years to confirm that goals have been attained. It also doesn't hurt to phone into investor relations to clarify any questions you might have regarding the company.
In Google Finance, management information is provided with a biography, compensation and trading activity for top-level executives. If you feel comfortable in investing in such a company, then that is the final piece of the stock picking puzzle.
[edit] Investment Decision
Successful stock picking is about using all the information available to you. If the three stock analysis methods coincide with attractive numbers in financial analysis, a buying opportunity according technical analysis, and good company management, you just might have a winning stock in your hands.