How to pick stocks for investment?

However you pick stock, write your reasoning (investment thesis) down so you can see whether it holds up and re-evaluate it later to see if you should adjust the strategy.

Advice on picking from Warren Buffett

The recommendations below constitute the core of the strategy called Value Investing. The idea is to buy healthy profitable businesses and hold for a long time.

• Buy below the intrinsic value,
• Look at the facts, not at what the others are doing,
• Study the business, not the stock price,
• Only buy businesses that you understand.

Advice on timing from Nigam Arora

This was the advice on how to predict that the trend is going to change (to pick best time for entering/exiting the market):

• Technical analysis:
  • Pay attention to price action on intraday charts.
  • Pay attention to support zones of DJI and SPX.
  • Watch put/call ratios on indexes:
    • SPY
    • DJX
  • Watch put/call ratios on popular stocks such as Nvidia NVDA and Facebook FB, along with other large-cap stocks.
    • Semiconductors:
      • NVDA
      • INTC
      • AMD
      • MU
    • Software:
      • MSFT
      • GOOG
      • AAPL
      • FB
  • Watch the price action in speculative stocks that are the crowd’s favorites, such as Tesla TSLA and Virgin Galactic SPCE.
    • TSLA
    • SPCE
  • Watch the price action and put/call ratios in stocks that are adversely affected by coronavirus, such as United Airlines UAL and Royal Caribbean RCL.
  • Watch China travel stock Trip.com Group TCOM.
  • Watch casinos with a presence in China, including Las Vegas Sands LVS and Wynn Resorts WYNN.
  • Watch makers of protective gear, such as Alpha Pro Tech APT and Lakeland Industries LAKE.
  • Watch stocks of companies that may have a vaccine or a cure, such as Gilead GILD and Moderna MRNA.
  • Watch volume for a washout.
  • Watch patterns traced by RSI (relative strength index), especially divergences.
  • Naked investors are concentrated in two groups: large-cap tech stocks such as Apple AAPL Amazon.com AMZN and Microsoft MSFT, and semiconductor stocks such as Advanced Micro Devices AMD, Nvidia NVDA and Intel INTC. For important clues, consider watching these six stocks to see if their relative strength slows.
• Fundamentals:
  • Listen to statements by Federal Reserve officials.
    • https://www.federalreserve.gov/newsevents.htm
  • Watch actions of the People’s Bank of China.
  • Watch for sentiment to become extremely negative.

General advice from Nigam Arora (ZYX method)

• Highest alpha is generated by noticing change before most market participants and acting on it:
  • Long term:
    • for Indexes - macro change,
    • for Stocks - change in future earning power,
    • for Speculative stocks - technological change.
  • Short term:
    • Change in sentiment,
    • Change in news flow.
  • Relevant kinds of change are the ones that alter risk/reward ratio.
• Assess how likely the change is to succeed and monitor it after buying to see if you should exit. The markets have high inertia (because momo) so smart investors have plenty of time to enter/exit based on the fundamentals.
• Money flow move the markets, so it's useful to notice significant changes in the flow of money into/out of the stock (buyer-driven trading vs. seller-driven trading).
• Quantitative indicators:
  • Free cash flow over last 8 quarters, future estimates, compared to peers in the industry,
  • Revenue growth trend in last 8 quarters, future estimates, compared to peers,
  • Valuation relative to history, peers:
    • see wikipedia
  • We avoid traditional quant trades by initially filtering based on change, not on these indicators.
• Technical analysis:
  • It's still quite relevant for determining best entry and exit points,
  • Meta-technical analysis: think what will people, who use traditional technical analysis, do and how will this drive the price.
• Managing risk:
  • Pick uncorrelated assets: different industries, different regions, etc.
  • Diversify strategies by time frame: short, medium, long.
  • Don't be afraid to be in cash, especially if there's a chance that better opportunities will be available.
  • Be data-driven and focus on long term risk-adjusted return.

Stock picking algorithm

This is one possible algorithm, it's definitely not the only one. It's somewhat inspired by value investment.

• Decide on the sector of the economy, understand what's going on in this sector and whether it's worth investing in generally speaking,
  • Some sectors will be easier for you to understand, maybe in some you have a relative advantage.
  • Diversification between sectors can reduce volatility (if the sectors you invest in are not very correlated).
• Look for attractive companies in the sector: indexes, screeners, news,
• Read their investment presentations: how do they make money and what's the current situation and trajectory,
• Check financials:
  • Balance sheets:
    • Shareholder equity,
    • Debt to assets,
    • Debt to equity,
    • Current ratio = current assets / current liabilities
    • Quick ratio = cash + marketable securities + receivables / current liabilities,
    • Receivables turnover = net sales per year / receivables.
  • Income statement:
    • Gross profit, profit margin,
      • Revenue - COGS
    • Operating profit (EBIT), profit margin,
      • GP - indirect costs (operating costs, depreciation, amortization)
    • Net profit, profit margin,
      • OP - interest - tax
  • Cash flow statement:
    • Operating cash flow,
    • Free cash flow,
  • Together:
    • Asset turnover - total sales / average assets,
    • ROA - Return on assets = net income / average assets:
      • Can be separated into a product of:
        • Profit margin (see above)
        • Asset turnover (see above)
    • ROE - Return on equity = net income / equity:
      • Can be separated into a product of:
        • ROA (see above)
        • Financial leverage = average assets / equity
• Think about the right price, see if you can get it for that price.

Useful ratios and what they mean

There are many ratios that are used to gauge the attractiveness of a company for investment. The current value of a ratio is not very meaningful by itself, however, comparing it to historical values and projections into the future show whether the company is getting better or worse. Also comparing to the rest of the industry and rest of the economy shows how it's doing relative to others.

• P/E ratio: market price of the company to earnings (total or per share, it doesn't matter),

Cognitive and Emotional biases in investment

https://www.pimco.com/en-us/book-biases