Regularly investing in a diversified ETF such as SPY is a great strategy for most people, but picking individual stocks can be a fun and rewarding challenge. It feels great when your research and hard work pays off.
In this column, I’ll briefly talk about how you can start picking stocks yourself. The discussion will be based on the fundamental analysis method, which seeks to find good companies by looking at their financial performance, products or services, and management’s competence, among other things.
One important thing to do is to learn some basic accounting so that you can read financial statements. Companies are like people: if they spend more than they earn, or owe more than they own, they will eventually run into financial trouble. Having some accounting knowledge helps you to understand how well a business is doing financially. There are plenty of learning resources online, or you could take an introductory course at Camosun.
It’s important to find out as much as you can about the company. For example, what products or services do they sell, and how popular are they? This can be a fun investigative step where you go out and observe businesses. For example, if you are thinking of investing in Starbucks, you could visit a few stores and see how busy they are. Also, read a company’s annual report, where management will discuss how their business has been doing, what they expect the coming year to be like, and a whole host of other very useful information.
I’m simplifying this investigative step to keep things brief, but in reality there’s a lot of legwork to be done. Not only will you need to learn about the company itself, you must also check out their competitors, the general condition of the industry, and monitor the news for any material events. I recommend Peter Lynch’s One Up on Wall Street as a great way to learn what to look out for when researching a business.
Money management is crucial when picking individual stocks. You never want to allocate so much of your portfolio to a single stock that it wipes you out if you’re wrong, because you will definitely get some decisions wrong. Stocks can and do sometimes go to $0, and you want to make sure that if that happens with one of your picks you live to fight another day. So decide on a maximum proportion—say, five percent—of your portfolio that you’re willing to risk on each stock, and be disciplined and stick to it no matter how great you think the company is.
Picking individual stocks can be fun and rewarding, but it also comes with much higher risk than investing in a diversified ETF. I recommend learning a lot more about the process before you begin, and starting small to test the waters.