Picking stocks is a lot like making any other important financial decision. It pays to follow a process that helps you identify what is important in the selection.
For example, what features are most important - long-term growth or a quick profit on a market shooting star? If you chose the quick profit, you are not investing, but speculating and no process will save you in the long-term.
When you have gone through the list of important features and made decisions where features were in conflict, you can't get a high return with no risk, you are ready to find the stock that most closely matches your list of important features.
If you are a savvy shopper, you take your time and only buy when you can get the stock at a good price. Buying at the right price is key to opening the possibility of a future profit.
All of these questions and more go into the process for picking a stock.
When you finally narrow done the process to a stock or several stocks, it is time to decide how much to pay.
This can be the hardest part of the process, especially if you are investing in growth stocks, which by definition tend to rise in price.
The price earnings ratio is one measure that investors use to tell whether a stock is over bought (priced too high) or oversold (selling below its true value).
Along with other ratios, PE is used to arrive at a value determination for a stock.
Many analysts, however, favor the fair value or intrinsic value method of stock valuation.
The intrinsic method is very complicated and quite detailed, so most investors rely on companies like Morningstar.com to make those calculations for them.
Value investors, in particular, are fond of intrinsic value analysis because it helps them identify companies the market is valuing (based on the stock price) below the real or intrinsic value.
These companies often realize substantial long-term gains when the market correctly prices (stock price) the company relative to its intrinsic value.
However, you need a process to get you to the purchase point and that involves research, comparing the stock to its peers and sector and determining the best price that will give you the most room to make a profit.
Many investors build in a "margin of error" into their ideal purchase price. This means they may reduced what research tells them is the ideal price by 15% or more.
This discount allows them to be somewhat wrong in their best estimate of price and still be in a position to profit.
The margin of error also makes it harder to find stocks that meet all of your requirements and price thresholds. This is where investors must be patient.
Rushing a buy decision can spell disaster if investors are not careful. It may also mean some stocks will never hit the target buy price and investors must simply let them go and move on to other opportunities.
It is better to pass on a great stock that doesn't meet your process requirements than to jump at a stock at a price that limits the possibility of profit in the long term.
There are always other opportunities, even though you may want to kick yourself when you watch a stock you took a pass on go through the roof. This should not change your process if you are comfortable with determining the correct price.
Be patient and profit in the long term.