(Source: smh.com.au)
Examine a particular company in the context of the wider economy when selecting stocks.
A reasonably firm domestic economy and improving conditions overseas have led many analysts to forecast that next year will be a good one for the sharemarket.
Nevertheless, the ride for investors could be rocky.
The result is that stock selection - always a significant consideration for serious investors - becomes more important than before.
What are the key ingredients of successful stock picking?
Talk to any group of experts and you will find they offer many varying methods. It is sometimes said that investing is not a science but an art.
Here are four considerations:
UNDERSTAND THE ECONOMY
For many professionals, the stock-selection process begins with a top-down examination of economic trends. "I like to see where I think the economy is going, both here and overseas," says a senior client adviser and strategist at Austock Securities, Michael Heffernan.
"That sets the canvas, or the foundation, on which I make my selections. Whether I expect the economy to do well or badly will influence which stocks I choose."
SEARCH FOR VALUE
Learn the fundamentals of the company in which you wish to invest. This is certainly the most important consideration for any investment decision and, while it may sound obvious, it is clear many investors have only a cursory understanding of the companies whose shares they buy.
"You need to do some legwork," says an equity analyst with the Fat Prophets market information company, Greg Fraser. "You need to know about the company, its industry and its competitors. You should understand its products or services."
This can all be seen as the qualitative side of the company. It is also important to look at the quantitative side - its financial statements. "Look at the earnings of the company, not just for this year but in a trend over time," he says. "You also need to understand the balance sheet and the cash flow statement. These can give you a feel for how highly geared the business is, its exposure to interest rates, whether it is sufficiently capitalised or not and so on.
"And once you put those things together, you then need to try and work out whether you think the company's shares are currently trading above or below what you think is a fair value."
The chief executive officer of the funds management and market data company Lincoln Indicators, Elio D'Amato, urges investors to pick stocks that are exhibiting dynamic growth.
"There are not many truisms in the sharemarket," he says. "But there is at least one - if earnings grow over the long term, the share price will follow."
This month his company released a shortlist of stocks it believes could outperform in 2011, including debt-collection agency Credit Corp Group, equipment rental finance specialist Silver Chef, engineering company Forge Group, retailer Thorn Group and internet service provider iiNet.
SPECIALISE
Select several areas of the market and develop an in-depth knowledge of these.
Controversial British businessman Jim Slater wrote a book on this theme, titled The Zulu Principle, after realising that his wife, with just a little reading, was becoming an expert in Zulus.
He advises investors to specialise in a narrow area of the market and to become an authority. He says doing this will allow recognition of small, dynamic growth stocks before most others.
RESPECT MARKET CYCLES
Author and educator Alan Hull manages the Alan Hull Books investor website (alanhullbooks.com.au). As an exercise, early in 2009 he drew up two portfolios, one comprising solid, highly rated blue chips and the other made up of "Dogs of the Dow" - large stocks that had been among the market's worst performers in the previous year.
In the rally of 2009, the blue-chip portfolio recorded a one-year return of 15 per cent. By contrast, the "Dogs of the Dow" soared more than 90 per cent.
"It was obvious that during 2009 we were in a bargain-hunter's environment," he says. "It was not a market that had reverted to fundamentals. That is not to say that fundamental analysis does not work. But it was not suited to that part of the market cycle.
"If someone says to me fundamental analysis is the best method, or technical analysis is the best method, I become very sceptical, because there is no single solution. It is a question of discerning where we are in a market cycle and then working out the most appropriate investment style. To be successful as an investor, one has to be open and remain humble to the market."
