How to Pick a Winning Stock like an Analyst

Investors are seeking knowledge on how to tap into the share market now more than ever, writes Bell Direct Market Analyst Jessica Amir.

One of the most frequently asked questions from budding investors is: what do I invest in?

And this question has only become more apparent as interest in the share market from retail investors peaked during the COVID-19 pandemic and the Google search for ‘how to buy stocks’ hit two record highs. As an online broker, we are increasingly seeing first time or beginner investors use the stock market as a saving tool by buying and holding quality stocks, as part of a diversified portfolio to set up their financial futures.

It’s not easy to pick winning stocks, nor is it easy to predict what will happen in markets – the COVID crash is a recent example of this. But there are some key principles you can follow to increase your chances of picking winners.

Consider the foundation: strong earnings and cashflow growth

Publicly listed companies are required to report their financial results to shareholders twice a year. Results must be reported within two months following the end of their balance sheet date. The two main reporting periods are in August, for full year results, and February, for half-year results.

Results are an opportunity look under the hood and examine how a company is performing. There is often a lot to digest, but a good place to start is the earnings and cashflow. Look for strong repeatable cashflows and growing revenue over time, as these indicate a solid financial foundation.

Typically, companies with growing earnings and cashflow generally also see share price growth and outperform the market over time. This can be explained by the old saying: earnings momentum is followed by share price momentum. 

It is also worth considering the outlook and guidance section of the results, as this can provide insight into the company’s future trajectory.

Boom or bust: what industry is it in

When picking a stock, it’s important to know if it’s in a growing industry or not.

Two examples of growing industries are the tech and health sectors, which have both seen a rise in demand due to the COVID-19 pandemic. When you consider the change in behaviour caused by COVID-19, the growth of these make sense.

With Australia officially in its first recession in 30 years, investors may be wondering what this means for their investment portfolio. Sectors that are classified as defensive, such as consumer staples and healthcare, tend to produce positive returns in recessionary cycles, which are up 4.4% and 4% respectively since the beginning of the year.

Although not a traditional defensive sector, the tech industry is also predicted to outperform during this low interest rate environment. The sector is up 30% this year, compared to the Aussie share market as measured by the ASX200, which is down 9.5%.

However, it’s important to remember: just because your company is in a growing sector, it doesn’t automatically make it a good investment!

Digging deeper: technical analysis

Academic studies have found there is great power when combining fundamental and technical analysis. If you wanted to take your stock picking to the next level, after you have found companies that are growing their earnings and revenue, you could then look at the stocks technical indicators.

Alternatively you could also do this process in reverse by looking at technical indicators first. Using this method, if you see that a stock is giving off bullish signals (indicating it will likely move higher) you would then dive into the company’s fundamentals (looking for earnings and revenue momentum) to back-up your investment decision.

As an example of stock picking success, Afterpay (ASX:APT) listed in June of 2017 at $2.70. I realised it became a household name when family and friends started using Afterpay’s buy now pay later service. There was clearly an appetite in the market, and it has now become one of the most popular ways for people to shop to help them stick to a budget when shopping.

Afterpay now dominates the buy now pay later segment in Australia. If you invested on the day it listed, just over three years ago, you could have made over 2,704%. But if you missed the IPO boat, and bought during the COVID19 lows (at $8.01), and held it today you would have made 730%.

What are the key takeaways from this example? Simply, consider the trends which are playing out in front of you and apply this knowledge to your stock picking.

To round it up

When picking stocks, you can either:

1. Go it alone, and invest based on your own research: Pick brand or business you know and trust, then explore its financial results to determine whether it has growing earnings and cashflows. Next you should look at recent media coverage to get a gauge on market sentiment and any major issues. Also question its future – will the company realistically be around in 5-10 years?
2. Leverage the tools and resources of an online broker: A good online broker will give you access to technical stock picking tools (based on fundamental and technical analysis). Additionally, investors should also be generally given access to their affiliated stockbroker’s research. For example, at Bell Direct our clients have access to Bell Potter’s ASX listed company research, with recommendations to either buy, hold or sell stocks.

The most powerful approach is a combination of both!

But whatever you do, remember – the earlier you get started, the more time you have to harness the wealth-building power of the stock market by letting capital growth, dividends, and compounding interest become your best friend.