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How to pick stocks: 8 steps for new investors
Balance your portfolio and maximize returns with well-informed stock picks.
Putting together your first portfolio doesn’t need to be daunting. We break the stock-picking process down into eight actionable steps any beginner investor can follow.
1. Determine what type of investor you are
Investors can be broadly sorted into two categories: active and passive. As the name suggests, active investors take a more hands-on approach to their investments and consistently monitor and manage their portfolios by making trades and analyzing stocks. Taking this approach to the extreme are day traders, who may buy and sell any number of stocks on a daily basis.
On the other hand, passive investors tend to favor a buy-and-hold approach and typically execute fewer trades. On the extreme end of the passive investment strategy are those who rely on robo-advisors or portfolio managers to manage their investments on their behalf.
A big part of knowing what your portfolio needs starts with identifying the type of investor you are. What are your financial goals, both short-term and long-term? And what do you hope to achieve with your investment portfolio?
2. Identify what your portfolio needs
Broadly speaking, stocks can be classified by the type of investment goal they’re best-equipped to serve:
- Income. Income investments pay regular dividends and typically include low-growth stocks, bonds and real-estate investment trusts (REITs). Income stocks are best for investors who want a steady trickle of income from their investments.
- Value. Value investments are designed to preserve wealth and hold their value: think blue-chip stocks like Microsoft or Disney. Value stocks are suitable for investors seeking a long-term asset that will protect their wealth.
- Growth. Growth investments come from young companies with plenty of growth potential. These stocks require active management and tend to be volatile — they’re best handled by experienced investors and day traders.
A healthy portfolio is a balanced portfolio. And that typically means holding an assortment of all three of these types of stocks in your brokerage account. Getting the ratios right ultimately comes down to what type of investor you are. For example, active investors may prefer a higher concentration of growth stocks, while more passive investors may prefer value or income stocks.
3. Choose a sector or industry
Once you’ve identified what type of stock you’d like to pursue, it’s time to select a market sector or industry. There are 11 stock sectors according to the Global Industry Classification Standard (GICS), and each of these sectors can be further broken down into 24 industry groups.
Many first-time investors find it helpful to start with what they know — which is to say: Pick an industry that personally interests you. Maybe you’re a tech junkie. Maybe you have aspirations of flipping houses or becoming a landlord.
Let personal interest be your guide, but don’t be afraid to rely on market news, industry newsletters and analyst recommendations for ideas. There are plenty of free resources for those just starting out.
4. Narrow down your stock choices
With a sector or industry in mind, you’re ready to start narrowing down your stock options. In any given sector there may be hundreds of stocks to choose from, so eliminating the stocks that aren’t suitable for your portfolio or budget is a critical step in the stock-picking process.
To help you filter out unsuitable stocks, consider a stock screener. Stock screeners are online tools designed to help you narrow your investment options by a variety of metrics. You can screen stocks by market, exchange, sector, industry, price and more.
Most online brokerage accounts come equipped with a stock screening tool that’s free to use so long as you have an account. But there are also quite a few free third-party stock screeners you can access online to help you do the job.
5. Analyze company financials
Found a potential stock for your portfolio? Understanding how to value a stock is integral for any trader. Here are some of the core pieces of financial data you’ll want to look at when considering a stock’s potential value.
- P/E ratio. Determine the price-to-earnings ratio by dividing a stock’s price per share by the company’s earnings per share. This articulates how expensive a stock is by revealing how much investors are willing to pay for a dollar of company profit.
- D/E ratio. As the name suggests, a company’s debt-to-equity ratio is a measure of how its debt stacks up against its equity. This figure can help you gauge a company’s financial health and can be found by dividing its total liabilities by its total shareholder equity. These figures can typically be found on a company’s balance sheet.
- Revenue growth. Examining a company’s total sales over a set period of time is a way of looking at its revenue growth. This helps you determine whether the company is growing or declining.
- Dividend yield. Does the stock you’re considering pay dividends? Not all do. Take a look at the stock’s dividend yield to get a better idea of how frequently the stock pays dividends and how the yield has grown or diminished over time.
6. Determine your timeline
Any talk of timelines boils down to the length of time you plan to hold onto a stock. For example, investors executing a buy-and-hold strategy may hold onto a stock for years, either waiting for it to increase in value or holding it as it rewards them with dividends — or both.
Day traders, on the other hand, buy stocks with the intention of quickly flipping them for profit — typically over the course of the same day.
Before you execute a trade, consider your investment goals against the type of stock you’re preparing to add to your portfolio. Have a clear exit strategy in mind: a clear definition of when it’s time to sell.
Are you willing to weather some volatility? How high or low does the stock need to be for you to get out? Committing to an exit strategy is a practical way to guard your portfolio from the types of losses triggered by impulsive investing.
7. Select your broker
To assemble your portfolio and execute trades, you’ll need a brokerage account. Compare commissions, fees and research tools to find the platform best suited to your investment objectives.
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8. Execute the trade
Once you’ve decided on a stock you’d like to purchase, it’s time to execute the order:
- Locate the stock. Log into your brokerage account and pinpoint the stock by searching for the company name or ticker symbol.
- Select your order type. There are numerous order types available, including market, limit, stop loss and stop limit orders. To purchase the stock right away at the current market price, select market order.
- Ensure you have enough buying power. Before you execute the trade, make sure you have the account funds to complete the transaction.
- Add the number of shares. Enter the number of shares you’d like to purchase and review the total cost of your order.
- Submit. After reviewing the order details, submit the order to execute the trade.
For those new to investing, the process of selecting stocks for a first-time portfolio can be overwhelming. Before executing any trades, take some time to assess your investment goals, select a strategy and review your brokerage account options.
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