Stock selection is not a difficult task. It is made out to be a lot more daunting than it really is because everyone focuses on getting it right on the first try. Sure, a healthy portfolio is every investor's goal, but achieving it requires some experimentation to get the right mix of stocks in one's portfolio.
The ideal portfolio has a mixture of stocks that meets the investor's individual needs in terms of risk and reward. A proper portfolio mix consists of risky stocks that possess great potential for returns and "safe stocks" that do not give much in terms of rewards but keep one's portfolio safe during unstable market conditions.
Most Indian investors have an "invest and forget" mentality, which needs to be abandoned. This does not mean that investors rebalance their portfolio too frequently, but when they do, there need to be more stocks than the ones they own in case their existing portfolio needs to be some major remodelling.
While selecting and buying stocks is a no-brainer, selecting the right stocks takes practice. However, it is not difficult and can be easily achieved with the right mindset. This article will outline a few things to remember to make your stock selection process much easier.
Flexibility is Key
One thing to remember is that the steps mentioned below will be guidelines, not rules or mandates that need to be followed down to the last letter. After all, people have wildly varying personalities, and as a result, their idea of an "ideal portfolio" will vary as well. So this is not a "one size fits all" formula.
The key is understanding that every investor needs to experiment to find the right combination for them. However, when experimenting, a little help may go a long way.
So, here are some guidelines to help you make stock picking easier than it already is.
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Observe the Leaders
As students, all of us have either been asked to look up to the academically gifted student's timetable/schedule or have been the student who has been asked for the same. While either of the situations has been almost equally awkward, the idea of looking up specimens that perform well to gauge their standing has been pretty helpful in certain conditions.
This is why, when it comes to stocks to purchase, it is a good idea to learn which stocks/sectors are performing well or not. Ticker by Finology is just the right platform for this appraisal. A fundamentally strong stock with good future prospects but frequently charting on the "Top Losers" list on the screening website might warrant some attention as a good buy.
On the contrary, seeing stocks that you own frequent the Top Gainer list could be a good sign that your portfolio consists of stocks that are presently performing well.
Get some Expert Help
Now that you have assessed the best and the worst player, you might have a general idea of industries or sectors that might perform well. Now, you need to hone in on the stocks that might work well for your investing style. While handpicking stocks is a valid way to go about this agenda, a good way to get yourself a headstart is to use the expert-made Bundles on Ticker.
Bundles are professionally curated collections of companies that follow a specific investment strategy. Ticker has "Efficient Banks", "Debt Independent", "Canslim Basket", and many more bundles to choose from. What's more, these "bundles" are not tied shut behind a paywall, they are free!
Bundles also give an idea of the metrics to look for in a company's shares. One such metric is the plethora of financial ratios that will be discussed below.
Fine-tune with ratios
You get a macro-economic view of things with Top Gainers/Losers and Bundles, but these compare a company to the rest of the industry. With these two filters, you might still end up with an overpopulated list of " good " shares. A final filter you can apply to refine your portfolio is financial ratios.
Financial ratios help investors truly gauge the performance of a company. Financial ratios bring together essential company information to help investors make informed decisions. Some of the most commonly used ratios are:
1. Current Ratio
This ratio helps find the company's short-term liquidity; or its ability to cover borrowing with terms shorter than a year. It compares a company's current assets with its current liabilities; thus, the formula for the Current Ratio is Current Assets/Current Liabilities. A current ratio of 2 or more is ideal as it means that the company's current assets can cover its current liabilities twice over.
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2. Debt/Equity Ratio
As the name suggests, the debt-equity ratio is a comparison of the two major elements of a company's capital structure; debt and equity. This ratio represents the company's funding structure. Ideally, the debt should be low, which would mean that the company's funds comprise more of the owner's capital instead of borrowings. Excessive borrowings put the company's assets at risk.
3. Price/Earnings Ratio
This ratio is relevant to the valuation of the shares of the company. It establishes the relation between each share's price and earnings per share. It helps the investor decide whether the return on each share is worth the price that it is currently selling at. A high P/E ratio means that the share is overvalued, and a low P/E ratio represents an undervalued share.
4. Earnings Per Share
This ratio represents the company's profits equally divided among each share. This helps the investor find how fragmented the company's profits get and what portion of the same is allocated to each shareholder. This ratio is also an element of the P/E ratio.
5. Interest Coverage Ratio
Not all the funds present in a company are its own. Borrowings form a part of this money. This ratio represents how secure a company's profits are against the interest it has to pay.
Finishing Thoughts
An "ideal portfolio" is a relative term, as it is affected by a multitude of factors. The investor's risk appetite, goal horizon, and fund availability are a few of these factors. Although such a perfect set of securities might seem like a stretch of imagination, the various tools mentioned above should make reaching this near-fairytale portfolio a lot easier.
That being said, finding good shares for one's portfolios does not mean an investor can kick their feet up and forget their financial standing with shares. Regular and prudent monitoring and shuffling of a portfolio are necessary if an "ideal" share fails to stand up to its standard.
Check out our latest course on - Professional Analysis of Financial Statements by Stuti Rajuka and CA Nishant Kumar: Click Here
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