How to Pick Stocks: Finding Companies to Invest In

The range of companies for British stock pickers to choose from is colossal. We’ll explain how to pick stocks in the UK and reveal some of the key places to find information.

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The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

Success through investing in the stock market is never guaranteed. But coming up with a plan on how to pick stocks can significantly boost an investor’s chances of creating long-term wealth.

There are literally thousands of shares that an investor can choose from on the London Stock Exchange. And most people don’t have a bottomless reserve of cash to call upon, so knowing how to pick the best stocks to buy is essential.

No blueprint exists to help us when it comes to picking stocks. Everyone is different when it comes to understanding a particular company or industry; how much risk we are prepared to tolerate; what investment goals we have, and so forth. All these variables have a huge impact on how you decide to pick stocks.

Here are the key things stock pickers need to think about before taking the plunge.

1. Think about your investment goals

Everyone has very specific investment objectives according to their own personal circumstances, whether it be saving for retirement, a down payment, or just some extra passive income. Whatever your circumstances, the time you have to invest, your risk tolerance, and even your own personal mindset will greatly affect how you think about picking shares.

For instance, many younger stock pickers prefer to focus on growth stocks. Because they have time on their side, they can prioritise higher-risk picks and look for companies that can grow earnings strongly and thus significantly rise in price.

On the other hand, someone who is preparing for retirement in 5-10 years may want to choose safer investments, as they will likely prioritize less volatile options with the shorter time span.

2. Consider which companies you’d like to invest in

There’s no point in limiting your options when you start out. The UK share market offers a great choice of companies for investors to select from regardless of their individual goals and tolerance of risk. And choosing several companies allows you to build a well-diversified portfolio, which reduces risk.

That’s not to say you’ll get to know the ins and outs of the balance sheet of every UK-quoted company. Not many of us have the time to sit down and go through every single one. But when you’re starting out it’s possible — perhaps even probable — that you already have a collection of stocks you’d like to check out.

Maybe you’ve just read about them in the paper. Perhaps you work for them or have done in the past. Maybe you’re a fan of their products and possibly even a customer. This can be a good jumping off point.

Having said that, it’s critical not to let your existing knowledge or personal experience of a particular stock cloud your judgment. You might love a company’s products or have had a good experience as a customer. However, this doesn’t necessarily mean it’s a profitable enterprise and therefore a good investment.

Once you have a list of companies you’re considering investing in, you’re ready to start researching.

3. Perform stock research

It’s impossible to do too much fundamental analysis while picking stocks. The more you know about a company, a sector, or the economy, the better placed you are to make a sensible and well-balanced investment decision.

You’ll want to evaluate a wide spectrum of key data, such as:

Carefully reading company reports is essential for stock pickers. This can, for instance, provide more information on a firm’s particular competitive advantage (or economic moat) and how this is helping to drive earnings.

4. Keep a wish list of companies

It also pays to have a ‘wishlist’ of individual companies you want to invest in constantly on the go.

Once you’re into the swing of things, watching the market and keeping abreast of economic and business news, it’s likely you’ll end up organically creating a list of companies you’d like to check out. Experienced stock pickers don’t sit down and build a watchlist from scratch when they come into money or are about to receive some. They already have a vague (or perhaps even detailed) idea of what to buy.

Having a potential shopping list of stocks gives an investor the advantage of readiness. If you already have a good idea of what you want to buy, you can be ready to strike if a particular share suddenly falls in price.

5. Stick to what you understand

A lot of novice investors fall into the trap of following the herd and buying what other investors are buying at any given time. Of course, some stocks are popular for very good reason. But following the actions and comments of others is certainly no substitute for doing your own research.

A particular danger for new investors is buying shares that they don’t understand. When you’re buying a share, you’re essentially purchasing a piece of a particular company. So surely you want to know in detail what it does and how it’s performing, right?

As legendary investor Warren Buffett famously said: “Never invest in a business you cannot understand.” The Sage of Omaha has amassed a fortune of around £100bn in more than 50 years of investing. So this is clearly a piece of advice worth listening to!

6. Be prepared to make mistakes

It’s well and good working out how to pick stocks and pinpointing which individual stock (or stocks) to buy. The next step — buying the stocks with your hard-earned cash and preparing yourself for potential negative impact — is another matter entirely.

However, making mistakes is all part of the investing journey. Stock pickers who haven’t sold a share at a loss or experienced disappointing returns are as rare as hen’s teeth.

Even the most experienced and successful investors make costly investing decisions. Take Buffett. He might be the world’s fifth richest man as this piece goes to print. But the Berkshire Hathaway boss has also made some costly mistakes down the years.

His ill-fated investment in Tesco is perhaps the most familiar to UK share investors. He loaded up on the FTSE 100 supermarket in the 2000s and early 2010s as it embarked on rapid international expansion.

Unfortunately for Buffett, Tesco’s share price slumped as trading conditions worsened and it exited international markets. It’s an error that ended up costing Berkshire Hathaway a whopping $444m when he eventually sold the company’s stake.

The longer you invest in UK shares, the more adept you become in spotting what to buy and what to avoid. Creating a winning investing strategy is a work in progress. The key is to keep plugging away and to put disappointments behind you.

And most importantly, to learn where you went wrong and how you can make better decisions in the future.

7. Don’t forget about funds

A final thing to consider is that the route to stock market riches isn’t just about knowing how to pick individual stocks.

As you’ve read thus far, taking the time to do proper research before investing is essential. But what about if you don’t have the time? Similarly, what if you don’t have the motivation to keep a watchlist of UK shares, or to go through balance sheets with a fine-tooth comb?

Falling into either (or both) camps shouldn’t preclude you from being able to make money from the stock market. An option for reluctant or time-starved investors is to invest in a managed fund. This is a collection of individual stocks which, for a fee, is hand-picked by a fund manager.

The problem here, however, is that managed funds rarely outperform simpler index funds, which track broader stock market movements, so what is right for you will completely depend on your personal preferences.

If you think an investment fund is a good route for you, opening a Stocks and Shares ISA account is a great first step.

8. Don’t let emotions take over

It’s critical to remember that the stock market is governed by emotion. Sure, a share might sink in price shortly after you’ve bought it, but that isn’t necessarily a sign of a bad investment decision.

As economist John Maynard Keynes famously commented: “The markets can stay irrational longer than you can stay solvent.”

Volatility is part-and-parcel of the stock market, so don’t let emotions rule your investment decisions. Buy stocks you believe in, hold them for at least 3-5 years, and be confident that if you’ve done your homework and invested wisely, there’s a good chance the company’s share price will rise over the long term as profits increase.

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.  

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a "top share" is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a "top share" by personal opinion.

As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk.