Guide to Stock-Picking Strategies

When it comes to personal finance and the accumulation of wealth, few subjects are more talked about than stocks. It's easy to understand why: playing the stock market is thrilling. But on this financial roller-coaster ride, we all want to experience the ups without the downs.

There are nearly 6,000 publicly traded companies in the U.S. While this represents a 37% decline in the number of U.S.-listed companies since its 1997 high, it’s still a lot of companies. How’s an investor to choose?

In this tutorial, we examine some of the most popular time-tested strategies for finding good stocks (or at least avoiding bad ones). In other words, we'll explore the art of stock-picking – selecting stocks based on a certain set of criteria, with the aim of achieving a rate of return that is greater than the market's overall average.

Some of these are simple: The Dogs of the Dow strategy, for example, is so easy that it literally takes a few minutes to learn how the system works. Growth and value investing, on the other hand, are complex – and these types of investors have to put in significant time to learn about valuation, financial ratios and the like.

In this tutorial, we’ll introduce nine stock-picking strategies, plus details on the first one. If you find one that interests you, please do all you can to learn about that strategy – read books and online material, watch webinars and attend live events – before investing any money. Keep in mind, this tutorial serves as an introduction to the various strategies, but there’s much more to learn. Patience is certainly a virtue when it comes to investing – not just in terms of waiting patiently for the right time to enter a position, but also for waiting until you’ve done your homework before you make your first investment. Your chances for success will improve greatly if you know what you’re doing.

[ Most long-term investors use fundamental analysis to find potential opportunities. If you're interested in learning these techniques, Investopedia's Fundamental Analysis Course will teach you the strategies and tools used by the most successful investing professionals. You'll learn how to analyze income and cash flow statements, spot weaknesses in a stock's balance sheet, and use valuation ratios to compare opportunities in over 67 lessons of on-demand video, exercises, and interactive content. ]

A few caveats before we get started: Many investors new to the stock-picking scene believe that there is some infallible strategy that, once followed, will guarantee success. There is no foolproof system for picking stocks! This doesn't mean you can't expand your wealth through the stock market. It's just better to think of stock-picking as an art rather than a science. There are a few reasons for this:

1. So many factors affect a company's health that it is nearly impossible to construct a formula that will predict success. It is one thing to assemble data that you can work with, but quite another to determine which numbers are relevant.

2. A lot of information is intangible and cannot be measured. The quantifiable aspects of a company, such as profits, are easy enough to find. But how do you measure the qualitative factors, such as the company's staff, its competitive advantages, its reputation and so on? This combination of tangible and intangible aspects makes picking stocks a highly subjective, even intuitive process.

3. Because of the human (often irrational) element inherent in the forces that move the stock market, stocks do not always do what you anticipate they'll do. Emotions can change quickly and unpredictably. And unfortunately, when confidence turns into fear, the stock market can be a dangerous place.

The bottom line is that there is no one way to pick stocks. Better to think of every stock strategy as nothing more than an application of a theory – a "best guess" of how to invest. And sometimes two seemingly opposed theories can be successful at the same time. Perhaps just as important as considering theory, is determining how well an investment strategy fits your personal outlook, time frame, risk tolerance and the amount of time you want to devote to investing and picking stocks.

At this point, you may be asking yourself why stock-picking is so important. Why spend hours doing it? The answer is simple: wealth. If you become a good stock-picker, you can increase your personal wealth exponentially. Take Microsoft, for example. Had you invested in Bill Gates' brainchild at its IPO back in 1986 and simply held that investment, your return would have been somewhere in the neighborhood of 35,000% by spring of 2004. In other words, over an 18-year period, a $10,000 investment would have turned itself into a cool $3.5 million! (In fact, had you had this foresight in the bull market of the late '90s, your return could have been even greater.) With returns like this, it's no wonder that investors continue to hunt for "the next Microsoft".

Let's start by delving into one of the most basic and crucial aspects of stock-picking: fundamental analysis, the theory that underlies all of the strategies we explore in this tutorial (with the exception of the last section on technical analysis). Although there are many differences among strategies, they all come down to finding the worth of a company. Keep this in mind as we move forward.