by David Opoku
Investors employ a multiplicity of techniques in choosing shares. What is common amongst the various methods is that they don’t always work. The suggestions made in this discussion combined with common sense and good judgment should help to hone your stock selection skills.
The first step in the selection process is asking yourself a few questions to help clarify exactly what you want and expect from your investment. It is immensely necessary to endeavour to find out the amount of risk you are prepared to take. Look back, and recall how you felt when you incurred some financial losses. Such memories, with some amount of honesty should help you to find out your level of risk tolerance.
Companies on the stock market are grouped on two main basis: in terms of similarity in size, and on grounds of carrying out the same activities (sector grouping). If your analysis shows you are risk-loving, then your focus should be on smaller companies or growth companies which are generally riskier, with potential for higher returns. If you happen to be the risk averse type or you want a share with minimum maintenance, then you want to consider large organisations, which have a lower tendency to go bust and can also serve as more reliable source of income. Such firms are known as ‘blue chips’. Target shares in industries or sectors that will be positively impacted on my political ventures and economic trends.
After considering the category of companies you want to deal with, you should begin inspecting the dividend yields and P/E ratios of the companies. It is a good idea to be on the look out for companies with reasonably high dividend yields. A P/E ratio between 7 and 10 is very much recommended. Remember that a P/E ratio is only useful when compared to others. Consider companies with P/E ratios that are lower than those of competitors in the same industry, and also lower than the previous years’ figures. The yearly sales and earning per share figures should ideally be increasing over the previous years. It’s a good idea to consider growth companies that have fallen on hard times, but shows signs of future recovery.
You should also decide how long you will be holding the share for. You will thus be on the alert, when it is time to get rid of the share. Higher returns will be earned when a share is held for a minimum of 5 years, with substantial savings in dealing expenses. This, nonetheless, does not mean that duds should not be turfed out before their planned disposal dates. Accordingly, a winner should not be gotten rid of just because it has had a decent run. Tact should be exercised before selling shares and it is good technique to keep an eye on the next share to grab, once the old one is gone.
Do not catch a falling knife. Although it is good practice to buy cheap shares, some shares suffer a free fall in price, and stay cheaper and cheaper with the passage of time. These should be avoided. Also eschew shares recommended by newspapers and tipsheets. The explanation for this is that market makers also read newspapers, and by the time you lay hands on the share, every advantage it has would have been already siphoned out by professional investors, especially, if you’re considering a blue chip. If you want to try your luck in securing a winner you may have to rummage financial statements of companies that have capitalisation less that £100 million. Such companies do not attract professionals, hopeful you can beat the market here.
It is almost impossible to outperform the market extensively. What you want to avoid is losses. A long-term goal of tracking the market, or better still performing slightly better than it is quite realistic and dignified. You should decide to what extent you want to get involved with the management of the share. If you want to be mildly involved, you will be better off investing in mutual funds or investment trusts rather than picking your own shares. Be prepared to buy investment management, when necessary.