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How To Pick A Stock

Part 1: Finding Great Companies

The framework behind picking individual stocks: start with the economy, narrow to the sector, then judge the business with a six-pillar checklist, spot the red flags, and learn how the big institutions play so you can play the parts of the game they cannot.

What you will learn

• The funnel: macro, then sector, then stock
• Pillar 1: is it a good business? Growth, margins, free cash flow, ROIC and a moat
• Pillar 2: can it survive a bad stretch? Debt, cash burn and dilution
• Pillar 3: what are you paying for it? P/E, price-to-sales and FCF yield
• Pillars 4 and 5: the catalyst and what the chart is saying
• Pillar 6: what can go wrong, and the red flags to walk away from
• Different stock types need different lenses
• Do institutions play by these rules, and where retail investors have room

Key terms in this lesson

• Free cash flow (FCF)The cash left after a company runs its business and pays for equipment.
• FCF yieldFree cash flow divided by a company's market value.
• ROIC (Return on invested capital)How much profit a company earns on every dollar put into the business.
• Economic moatA lasting advantage that keeps competitors from copying a business.
• DilutionA fall in each owner's share of a company when it issues new shares.
• P/E ratio (price-to-earnings)A stock's price divided by its earnings per share.
• P/S ratio (price-to-sales)A company's market cap divided by its yearly revenue.
• Relative strengthHow a stock performs compared with a benchmark or its sector.
• Moving average (MA)The average closing price over a set number of recent periods, plotted as a line.
• CatalystA specific event that can change how the market values a stock.
• Cyclical stockA stock whose earnings rise and fall with the economic cycle.
• Sector rotationThe shift of money from one sector to another as the economic cycle changes.
• Value trapA stock that looks cheap but is cheap for good reason, because the business is declining.
• Debt-to-equity ratioA company's debt compared with its shareholders' equity.
• Cash burnHow fast an unprofitable company is spending its cash.
• Institutional ownershipThe share of a company held by funds, pension plans and other large institutions.
• Position sizingDeciding how much money to put into a single trade.
• Stop lossA pre-set exit point that limits how much you lose on a position.

Try it in PDB