How to choose stocks, and build your stock portfolio
When it comes to selecting stocks for your portfolio, there are a few things to keep in mind. First, you should consider your investment goals and capital to determine the proportion of longer-term versus shorter-term stocks you should include. If you have larger capital, you may want to choose more stable, value stocks of well-known companies. If you have smaller capital, you may want to focus more on shorter-term growth stocks that can generate broader profits.
To determine the exact portion of each stock in your portfolio, you can use different portfolio management models such as the Markowitz model. However, if you’re not familiar with these models, you can use a web-based app like Diversset to help you find Stock tailored to your investment goals and construct an efficient portfolio.
When it comes to the stock selection process, you should start with an idea and see what the most interesting stocks for the short term and long term are. For example, during a COVID lockdown, discount store stocks were popular due to people losing their jobs and trying to save money. Value stocks of larger companies were also in demand because many Americans were receiving government help during COVID times and investing in popular, well-known companies’ stocks.
Short-term stock selection heavily depends on the current moment and what will be in high demand among people. Long-term stock selection depends on a company’s vision, debt structure, positive and stable FCF dynamics, good operating numbers, decreasing costs, and other things from financial reports. You should also like the company and understand its operations to accurately calculate and forecast financial data.
After you’ve found stocks that look cheaper than their peers, you can use financial ratios such as P/E, P/FCF, and PEG to compare the company to its closest peers. However, the financial ratios you use should depend on the company’s industry, product, or service.
Once you’ve found stocks that look promising, it’s time to analyze the company’s business and services. Read the management’s letter to understand their vision for the company’s long-term goals, expansion, market share, and current challenges. This information is essential for making accurate forecasts.
You can then examine a company’s financial statements to make financial forecasts, examining costs, income, revenue, assets, debt structure, and FCF. You should also examine the cost of money on the money market to forecast the company’s FCF and calculate WACC (required rate of return). Then, you can calculate the company’s terminal value, discount TV, and FCF by the WACC, sum everything up, and get the company’s Enterprise value.
Once you’ve determined the company’s Enterprise value, you can add cash and subtract the company’s debt to get the company’s market capitalization. Finally, divide the market capitalization by the number of the company’s shares to get the company’s target price. This model is called DCF and is mainly used for larger companies. If the company is smaller and not paying dividends, you may use only multiplicators and skip this step.
If you don’t have expertise in calculating a stock’s target price or don’t have time for manual calculations, you can use an iOS application like Stock Target Price to calculate the stock’s target price. The app uses the Prat and Gordon model to forecast dividends and then discounts the dividends by the required rate of return.
Once you’ve decided on which stocks to buy, it’s time to construct your stock portfolio. You can use a web-based app like Diversset or do manual calculations to do this. For manual calculations, use the Markowitz model to distribute asset weights in your portfolio so that you will have minimum possible portfolio loss given your required return.
The portfolio management models are used for the stock portfolio risk minimization. If you use the MArkowitz model you can build an efficient portfolio.
I hope my article was clear and you understand how to choose stocks and build an efficient portfolio