How to pick stocks: important criteria for picking stocks
If you had invested $1000 in Amazon just 10 years ago, you would have $18,000 today. Investing in the stock market can be a very rewarding experience. Studies have shown that the top 10% of the wealthiest Americans invest in the stock market. In this article, we will explore the secrets of the successful investors who have made millions in the stock market. If you learn how to pick the right stocks, it can change your financial future forever. You too can become the next billionaire.
Picking stocks and Investing in the future
The stock market rewards investors who are able to look into the future to spot trends. Plus, the companies that are the leading innovators in those trends. As you are getting ready to pick stocks, you should pay attention to some of the important trends. Those vital trends are happening in the world. They are changing our lives today and in the future. For examples , 5G, artificial intelligence, robotics, self driving cars, genetic engineering, e-commerce, and 3-D printing or so on. In your hunt for the right stock look for companies which are leading the way in these innovations.
Here are some examples of companies that are the leaders in their respective fields:
E-commerce: Amazon (AMZN), Shopify (SHOP), Sea Limited (SE), Mercadolibre (MELI)
Digital advertisement: The Trade Desk (TTD), Magnite (MGNI)
5G: Google (GOOGL), Microsoft (MSFT), Twilio (TWLO), Roku (ROKU)
3D printing: 3D Systems (DDD), Exone (XONE)
Artificial intelligence: C3.AI (AI)
Electric and autonomous vehicles: GM (GM), Tesla (TSLA)
Genetic engineering: Crispr (CRSP), Intellia Therapeutics (NTLA)
Studying companies’ business models
When you pick stocks, you should always look at the company’s business model. The legendary investor Warren Buffett once said that you should always understand the companies that you are investing in. Before investing in any company, I would recommend that you read the investor presentation. Specifically, you should study their business model in order to understand how they are making money. When you study a company’s business model, you should pay attention to things like unit economics. Let’s say a company is selling a product for $10 and it costs them $15 to make the product. That company has pretty bad unit economics. Even though the revenue might be very high, they will be losing money on every sale.
On the other hand, marketplaces like Uber or Airbnb have a different business models. Such companies might need to provide incentives for the buyers or sellers to join the marketplace. This may result in those companies making a loss initially while they are trying to grow the marketplace. Once, the marketplace has been established with sufficient buyers and sellers, the company would start making good profits.
Revenue growth – a vital factor to pick stocks
Revenue growth is an important factor to consider when you pick stocks. The stock market rewards companies that are growing very fast. Market capitalization is often looked at, as a function of revenue. Fast growing companies usually trade at a higher multiple of revenue than slower growth companies. It is normal for high growth companies to trade at 30, 40 and sometimes even 50 times the revenue. Slower growing companies might trade at just 2 or 3 times the revenue. If stock price appreciation is important to you, you may want to consider investing in companies with a track record of consistent high revenue growth. If your appetite for risk is lower, you may want to consider investing in larger more stable companies. Especially companies often pay a dividend such as Booking Holding Fund (BKNG), Onemain Holding Inc (OMF) , etc.
Addressable market – the opportunity for a company to grow
The addressable market for a company’s products puts a ceiling on how much a company‘s revenue can grow. When you pick stocks it is important to select companies that have a very large addressable market compared to their current revenue. Such companies have a good opportunity to grow into their addressable market.
For example, according to The Trade Desk’s (TTD) recent presentation, it has less than 1% of the total global advertising market today. However, the total addressable market is $725 billions. This means that Trade Desk has plenty of room to grow.
As another example, the addressable market of self driving taxis is considered to be in the trillions of dollars. Hence, the valuation for companies like Tesla that promise to deliver self driving taxis is very high.
Stable growth – indicates a company’s strength
When you pick stocks to purchase, you should look at companies that have a track record of stable growth. If a company grows very fast in one year and slows down in subsequent years, indicates that there is a potential weakness in the company‘s business model. By reviewing the company‘s financial statements over the last 3 to 5 years, you would indicate if the company is able to grow revenue in a stable manner.
As an example, lets look at Shopify’s revenue growth. You can see how the company has been consistently growing its revenue year after year. Investors appreciate such growth and reward companies like Shopify with high valuations.
Price to earnings ratio – how expensive a stock is
When picking the right stocks to buy one of the metrics that financial advisors look at, is the price to earnings ratio. The price to earnings ratio is exactly as it sounds. It is the ratio of the stock price of the company compared to the company’s earnings. When you are looking at a stock quote using applications like Robinhood, Yahoo Finance or Google, they will normally show the companies P/E ratio. If the P/E ratio is very high, it often indicates that the stock is very expensive. So, a conventional wisdom is to wait until the P/E ratio comes down.
However this rule does not necessarily apply to some high growth companies. Those companies are growing at a tremendous rate. For example, the company Zoom increased its subscribers from 10 million to over 300 million during the pandemic. Its huge potential for future earnings is not reflected in the current P/E ratio. The stock market is always forward-looking. The stock price takes into consideration the future revenue of the company and not just the current revenue
The CEO – the key of a company’s success
The CEO has an outsize influence on the success or failure of the company. Statistics have shown us that when the CEO is also a founder of the company, the company performs exceedingly well. Amazon, Facebook, Microsoft are all examples of founder led companies which went on to become very successful. If the CEO of the company has a substantial stake in the company, investors can be confident that his/her decisions will be aligned with the benefit of the shareholders.
Customer reviews – customers’ satisfaction metrics
In order for a company to be successful, its customers must love its products. Before you make a decision on investing in any company, I would recommend doing research on the company’s product customer reviews. If customers are raving about a company’s products, it is an indication of the company’s strength. Hence, there is a strong possibility of future growth as current customers recommend the company’s products to people they know. On the other hand, if you see a lot of negative reviews, and the company is not responding to those unhappy customers, you would do well to stay away from that company’s stock.
Insider Trading – the company’s future prospects
Before investing in a company, it is worthwhile checking what the company’s insiders are doing. Note that many companies pay their employees in stocks. These employees may need to sell their stock at some point. Some insiders are selling the stocks does not always mean that there is something wrong about the company. However, It is a red flag if you notice that the top executives are completely selling out of their positions. You would want the senior management of the company to continue to hold a significant stake in the company, so their decisions would be aligned with the best interest of the investors.
On the other hand, if you notice that a lot of the insiders are buying a stock, it is a positive signal. Since it usually means that they know something good about the company’s future prospects.
I hope the above tips have been helpful to you in your search for the right stocks to buy. Please note that the above is only my opinion. And you should not be considered financial advices. Before making any investment decision, you should do your own research and consult your financial advisor. Happy investing, and wishing you great prosperity in your journey as an investor!
