How to pick shares: The key elements investors should consider (2024)

Increasing numbers of DIY investors are deciding to buy individual shares in their SIPPs and ISAs to grow their wealth, and well they might given the hugely democratising influence of the internet.

Information on companies has never been as easily accessible as it is today, which makes the job of picking good stocks something private investors can participate in, if they’re willing to put in the elbow grease to thoroughly research their potential purchases.

But what are the metrics and resources investors should turn to when selecting investments?

Retail investors must consider a range of metrics before selecting a stock to invest in

Probably the biggest store of valuable information for investors lies in the results and reports presented by companies to the stock market.

Institutional investors have no special treatment compared to private investors here; the results are delivered to the market as a whole at the same time, and for UK stocks can be found on the London Stock Exchange website at 7am each day, or on companies’ investor relations websites.

These reports are a treasure trove of information. Laith Khalaf, financial analyst at investment platform AJ Bell, picks some key things to look out for.

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Earnings Per Share

One of the most important figures in company results is the Earnings Per Share (EPS) figure. This tells investors what profits the company is making for each share they hold.

There are two main ways to look at this figure. First, consider how it compares with prior periods to see if earnings are heading in the right direction, taking into account any one-off boosts or dents in profits that aren’t repeatable.

The Chief Executive’s commentary which goes along with the results should alert you to such factors, particularly the ‘outlook’, which looks ahead to the following year.

Second, divide the share price by the Earnings Per Share figure to derive the Price Earnings ratio, which is a measure of how expensive the shares are compared to the profits the company generates. Make sure you only use the annual Earnings Per Share figure in this calculation - you will get a wonky ratio if you use the earnings from a half year report because you’re only looking at part of the picture.

Alternatively, you can also get the Price Earnings ratio from other sources such as the websites of some investment platforms, brokers and media outlets. You might be willing to invest in companies with higher Price Earnings ratios if you think there are good prospects for those earnings to grow quickly.

Dividends

The dividend is another key figure in the reports and accounts for investors to mull, especially income seekers. Again, it’s a good idea to compare it with previous periods to see if the income payment to shareholders is growing.

It’s also worth comparing the dividend per share to the earnings per share and considering how big a proportion of profits are being paid out as dividends. If it’s a high percentage, it may be a sign that dividend growth is likely to be limited, or in extreme cases that the dividend is unsustainable.

You can also divide the dividend per share by the share price to derive the stock’s historic yield, which again is available on many investment websites free of charge.

Of course, there are some companies which don’t pay a dividend, preferring instead to reinvest profits in the business, and here this measure can’t be used. Big tech companies like Amazon and Alphabet are renowned for this growth-hungry approach which shuns dividends.

Profit margins

It's worth also looking at a firm’s profit margin. Usually this will be presented in the results, and it tells you what percentage of revenues flows through into profits, which ultimately determine a company’s performance.

A low profit margin means a company has little room for error or misfortune before slipping into the red, while a larger margin means the company is better placed to weather any storms while still turning a profit.

Bear in mind some industries simply have low margins, for instance supermarkets and construction. While it may be less of an issue for the former as consumer demand for groceries is relatively stable, construction projects can often run late or over budget, wiping out profits and leading to losses - precisely what happened to Carillion before it collapsed.

Debt

Investors should also pay heed to how much debt a company is carrying. In annual results, net debt is the key figure here. Again you can compare with previous periods to see if it’s heading in the wrong direction, which could be a warning sign.

You can also divide net debt by EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) as this figure is often provided in the results.

This ratio gives an indication of how many years it would take a company to pay off all its debt at current levels of profitability. Generally a Net Debt to EBITDA ratio of less than 2 is considered healthy, and a ratio above 3 starts to raise eyebrows.

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Broker forecasts and ratings

There are plenty of other measures to look for in the results too, if you really want to roll your sleeves up, and also other resources you can use outside company reports which might help.

Laith Khalaf: Investors should give thought to portfolio diversification

For instance, on their investor relations websites, many large companies will provide the average of professional analysts’ estimates of earnings in the forthcoming year (known as the consensus estimate). This can give you an idea of market expectations for a stock, and in the short term, share price movements will be guided by how actual performance measures up to these forecasts.

Broker ratings are also available on many websites, which tell you whether analysts rate a company as a buy, hold or sell.

These don’t tend to be very useful however, as there are usually as many saying sell as there are hold or buy. And when there is clear analyst agreement on a stock, that’s usually baked into the price.

Overall you might want to look at analyst ratings and estimates to get an idea of how the market views a stock, but it shouldn’t play a major part in your investment decision. Analysts tend to focus heavily on the next twelve months, whereas investors should be thinking about becoming an owner of a company for five to ten years or more.

Portfolio diversification

As well as picking good companies to hold for the long term, investors should of course give some thought to portfolio diversification. If all the companies you select are in the same country, or in the same industry, then your portfolio will be extremely vulnerable to a downturn in those areas. So make sure you’ve got a good spread of investments.

You should also make sure there are enough companies in your portfolio to minimise the impact of one performing particularly poorly, or worse still, going bust.

As a rule of thumb, the professional fund managers with the most concentrated portfolios still have around 30 stocks in there. That probably sounds like quite a lot for most private investors, particularly seeing as you need to regularly review your holdings as well as picking them in the first place.

A TRICK TO DIVERSIFY QUICKLY AND SIMPLY

There is a trick you can use to reduce the number of companies you invest in, while maintaining diversification however.

By picking a few diversified funds as the core of your portfolio, you can then supplement this with some individual shares, safe in the knowledge that your portfolio diversification is still intact thanks to the funds you hold, Khalaf says.

In this way you can hold a smaller number of shares, or perhaps build up your stock portfolio from scratch over time, without overexposing yourself to one area of the market. Index tracker funds which invest across the whole market can work particularly well as core holdings in this strategy.

That’s because by investing in individual stocks alongside index trackers, you are basically tilting market performance towards the companies that you have selected.

As well as providing diversification, that also means if you’re get your stock picks wrong, you’ve got a safety net in the form of the index trackers delivering market performance for you. If you’re going to be an active stock investor, you have to accept that you will get some things wrong, so protecting your portfolio from your own mistakes should always be a key consideration.

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How to pick shares: The key elements investors should consider (2024)

FAQs

How to pick shares: The key elements investors should consider? ›

The first and foremost factor to consider when selecting stocks is the company's fundamentals. This includes examining the company's financial statements, such as its income statement, balance sheet, and cash flow statement. Pay attention to metrics like revenue growth, earnings per share (EPS), and profit margins.

What factors should investors consider when choosing a stock? ›

Investors have traditionally used fundamental analysis for longer-term trades, relying on metrics like earnings per share (EPS), price-to-earnings (P/E) ratio, P/E growth, and dividend yield.

What are the main elements to consider when investing in a share? ›

Investing has a set of four basic elements that investors use to break down a stock's value. In this article, we will look at four commonly used financial ratios—price-to-book (P/B) ratio, price-to-earnings (P/E) ratio, price-to-earnings growth (PEG) ratio, and dividend yield—and what they can tell you about a stock.

How do I choose a good share for investment? ›

Key Takeaways
  1. Decide what you want your portfolio to achieve, and stick with it.
  2. Pick an industry that interests you, and explore the news and trends that drive it from day to day.
  3. Identify the company or companies that lead the industry and zero in on the numbers.

What do investors look for when buying shares? ›

The company's revenue growth, profitability, debt levels, return on equity, position within its industry and the health of its industry are all metrics you should consider prior to making an investment, Sahagian says.

What is the most important indicator an investor should consider when choosing a stock? ›

Price-to-Earnings Ratio

The P/E ratio is important because it provides a measuring stick for comparing whether a stock is overvalued or undervalued. A high P/E ratio could mean that a stock's price is expensive relative to earnings and possibly overvalued.

How do investors decide what to invest in? ›

To know the right allocation strategy for you, you need to understand your tolerance for risk. If temporary losses keep you awake at night, concentrate on lower-risk options like bonds. If you can weather setbacks in the pursuit of aggressive long-term growth, go for stocks. Neither is an all-or-nothing decision.

What is the formula for picking stocks? ›

P/E Ratio – The P/E ratio is a calculation that evaluates a stocks relative performance and value. It is computed by dividing the stock's price by the company's per share earnings for the most recent four quarters.

What are the 4 main components elements to a stock? ›

Basic Elements Of Stock Evaluation
  • Price to Book Ratio.
  • Price to Earning Ratio.
  • Price to Earning growth ratio (PEG) ratio.
  • Dividend Yield.
Apr 14, 2023

What do you need to consider when buying a share? ›

Some of the things you can look at include:
  1. Earnings per share. This helps you work out how much income the company generates per issued share.
  2. Price Earnings ratio or P/E. This lets you see how much of the share price is backed up by earnings.
  3. Dividend yield. ...
  4. Return on equity.

How do you decide which shares to buy? ›

Six ways to research a stock before you buy
  1. Look at what the company does and how it generates revenue. ...
  2. Check out its financials. ...
  3. Use price charts to spot important trends. ...
  4. Monitor the stock. ...
  5. Look beyond the numbers. ...
  6. Hear what the experts have to say.

How do you pick winning shares? ›

Read up on the company you're interested in and get to know their business model and financials. Check out analyst reports and look at the stocks they recommend. You can also use tools like stock scanners to find stocks with specific criteria.

How do you decide if a stock is a good investment? ›

Evaluating Stocks
  1. How does the company make money?
  2. Are its products or services in demand, and why?
  3. How has the company performed in the past?
  4. Are talented, experienced managers in charge?
  5. Is the company positioned for growth and profitability?
  6. How much debt does the company have?

How do investors choose stocks? ›

  • Determine your investing goals. Not every investor is looking to accomplish the same thing with their money. ...
  • Find companies you understand. ...
  • Determine whether a company has a competitive advantage. ...
  • Determine a fair price for the stock. ...
  • Buy a stock with a margin of safety.
Nov 13, 2023

What should you consider when investing in shares? ›

Price-earnings ratio (P/E) — A way of working out if the price of a share is over or under-valued compared to its competitors. In general, the lower the ratio, the better. A low ratio could also mean the market expects earnings to be lower in future. To work out the P/E ratio, divide the share price by the EPS.

What are the factors to consider when buying shares? ›

Making your first stock purchase? Here are 10 crucial factors to help you choose the right shares
  • Define Your Investment Goals. ...
  • Understand Your Risk Tolerance. ...
  • Research and Due Diligence. ...
  • Fundamental Analysis. ...
  • Technical Analysis. ...
  • Diversify Your Portfolio. ...
  • Consider Dividends. ...
  • Evaluate Management Quality.
Jan 11, 2024

What factors to consider when making a stock? ›

The Cardinal Rules of Stock Making
  • NEVER SALT STOCK. Ever. ...
  • SKIM STOCK OFTEN IN THE BEGINNING. ...
  • NEVER BOIL STOCK. ...
  • THE BETTER YOUR INGREDIENTS, THE BETTER YOUR STOCK. ...
  • STRAIN YOUR STOCK WHEN IT COMES OFF THE STOVE. ...
  • ALWAYS DROP YOUR STOCK QUICKLY (UNLESS YOU'RE USING IT IMMEDIATELY) ...
  • CAN YOU BREAK THESE RULES?
Oct 14, 2021

What are the three factors that investors must consider when making investments? ›

The options for investing your savings are always increasing but they can all still be categorized according to three fundamental characteristics: safety, income, and growth. The first task of any successful individual investor is to find the correct balance among these three worthy goals.

What factors should an investor consider while making an investment decision? ›

  • A Financial Plan. In investment decisions, you should be able first to draw up a financial roadmap that works. ...
  • Risk. An intelligent investor must evaluate their comfort zone in making a financial investment, referring to the risk. ...
  • Investments mix. ...
  • Investment term. ...
  • Liquidity. ...
  • Inflation rate. ...
  • Steer clear of scammers.
Jun 9, 2023

What are the 5 key elements that investors consider when deciding whether to invest in a company? ›

Use five evaluative criteria: current and projected profitability; asset utilization; capital structure; earnings momentum and intrinsic, rather than market, value. Ask whether an investment is consistent with your asset allocation and if a stock's characteristics are within your risk-tolerance levels.

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