A Winning Stock Picking Strategy

When fundamental and technical factors coincide in a hot sector, the demand for the stock increases exponentially.

Checking the following criteria for each stock pick is one of the most important steps in the stock-picking service.

Earning Per Share

Cash Flow

Annual Growth

Relative Price Strength

Profitability

Industry Leader

Financial Health

Debt

Management

P/E Ratio

Competitive Advantage

Institutional Sponsorship

Direction of the Market Averages

Insiders trading

Industry/Sector

Psychology of Trading

Technical Indicators: Support & Resistance

Earning Per Share (EPS): Current quarterly earning per share. Earning per share is calculated by dividing a company's total after-tax profit by the number of common shares outstanding. The percentage change in earning per share is one of the most important factors in stock selection. The higher the percentage increase, the better. Always compare a company's earning per share to the same quarter a year earlier not to the prior quarter, to avoid any misrepresentation due to seasonality. Earning Per Share alone can not be the true measure of a company's financial performance. For a number of reasons, accounting-based earnings per share can be made to say just about whatever a company's management wants them to, but there are other valuation data that are much harder to swindle with. Cash Flow: The amount of cash a company generates and uses during a time period. Cash flow is calculated by adding non-cash charges to the net income after taxes. Cash flow can be used as an indication of a company's financial strength. Cash flow is critical to companies, having plenty of cash available will guarantee that employees, creditors, and others can get paid on time.

The Statement of cash flows records all the cash that comes into a company and all that goes out. It can yield a ton of information about the true health of a business, and you can spot a lot of blowups relative to earnings. For example, if operating cash flow declines or disappears even as earnings grow, it's likely that something is not right.

The cash flow statement is divided into three elements: cash flows from operating activities, from investing activities, and from financing activities. Annual Growth: Annual earning increase of a company. The growth of earning in the past few years confirms the financial strength and stability of a company. The higher the growth, the better. When you compare two different companies the company with higher growth percentage and lower P/E ratio would be a better selection.

Concentrate on stocks with established records of considerable earnings growth in each of the recent years plus strong quarterly progress. Remember to find out what is the source of the growth. You can't just look at a chain of past growth rates and believe that they'll predict the future. If investing were that easy, money managers would be paid much less. There are four sources that cause healthy growth for a company: selling more products or services, raising prices, selling new products or services, and buying another company.

Relative Price Strength: Relative price strength is a benchmark in which you can compare the price performance of different stocks. In order for a stock to be a leader in a particular industry its price action should outperform other stocks in that industry. When selecting a stock as a momentum play you should look for companies with high relative price strength. The absolute number one market leader is not the biggest company or the one with the most known brand name; it's the one with the best quarterly and annual growth and price action. In a bull market, strong stocks with higher RS usually decline the least in the market corrections.

Profitability: profitability is theamount of profit that a company is generating relative to the amount of money invested in the business. This is the best way of separating great companies from average ones. Return on assets (ROA) and return on equity (ROE) are two tools that can be used to asses how efficient a company is.

Industry Leader: The top two or three stocks in a strong industry group can have incredible growth, while others in the group may barely move. You should buy the best companies, the ones that lead their sectors and are number one in their particular field. The number one market leader is not the biggest one. It is the one with the highest annual growth, earning per share, and price relative strength. It's a company that has competitive advantage over its competitors. A company that is offering the best product.

Financial Health (Company's Debt): Once you figure out how fast a company is growing and how profitable it is then you need to find out about its financial health. The bottom line about a company's financial health is its debt. If the company's debt is increasing and company is growing fast at the same time, the extremely high earning of the company is high enough to cover the fixed cost of debt repayments. When business is bad, however, the cost of debt pushes earnings even lower.

You should asses the financial health of a company before buying its stock especially if the interest rate is increasing. Financial statements of a company provide the information about the amount of company's in comparison with the earlier quarters/years.

Management: Great management can make a difference between an average business and an extraordinary one. Your goal as an investor is to find management teams that think like shareholders; executives who treat the company as if they own a piece of it. One way to find out about the management and how much they really care about share holders is to check the top executive's compensation plans. We review the compensation detail in a document called proxy statement. Big bonuses are always better than big base salaries. Bonuses mean a chunk of the income is always at risk and depends on the performance of the management.

P/E Ratio (Price/Earning) : Most popular valuation ratio, which can take you pretty far as long as you're aware of its boundaries. An easy way to use P/E is to compare it with a benchmark, like another company in the same industry, the entire sector, or the same company at a different point in time. A company that is trading at a lower P/E than its industry peers could be a good value, but remember that even companies in the same industry can have very different money structures, risk levels, and growth rates, all of which affect the P/E ratio.

If a company has a P/E higher than the market or industry average, this means the market big expectation from the company over the next few months or years. A company with a high P/E ratio will eventually have to live up to the high rating by considerably increasing its earnings, or the stock price will need to fall.

Competitive Advantage: Success attracts competition and eventually laggard companies come into competition and cause the stock price of a company that has been a leader for a while to drop. Generally, there are different ways that a company can create sustainable competitive advantage:

1. Creating a real different product (Apple iPod)

2. Creating a strong brand (Tiffany)

3. Keeping costs down (Dell)

4. Lockingin customers by creating high switching cost (Cisco)

5. Locking out competitors (Using patent for drug companies)

Institutional Sponsorship: The key to know about the institutional sponsorship is the number of financial institutions that have bought or sold the stock in the recent months. Technically, it considered to be a good sign if a company has increasing number of institutional owners over several recent months. Financial institutions can not hide since they usually trade huge number of shares. By following the buy and sell volume in a daily chart you can notice if mutual funds and banks are buying a stock.

Market Trend: Detecting the current trend of the market is the first and most important part of our stock pick system. More than 75% of your trades will end up in a loss if you fight the trend. As part of our stock pick strategy we constantly review the conditions of the market averages.

Insiders Trading: It is always good if you monitor insider's transaction when you are picking a stock. You don't want to buy a stock when insiders of the company are selling a significant amount of the company's stocks. Insiders usually sell their shares for various reasons but when the number of shares and the frequency of unloading them are unusual you should be more careful. On the other hand, there can be only one reason when they buy their company's shares, they want to make money. Insider trading is a term that most investors have heard and usually relate with unlawful conduct. But the term actually includes both legal and illegal conduct. The legal version is when corporate insiders such asofficers, directors, and employees buy and sell stocks in their own companies. When corporate insiders trade in their own securities, they must report their trades to the SEC.

Since insider trading weakens investor confidence in the fairness and integrity of the stock markets, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.

Industry: Industry is a grouping used to describe a company's main business activity. It is generally determined by the major source of a company's income. A hot sector is a sector of the economy experiencing a higher than regular growth rate. If companies across an industry show solid earnings and revenue figures, that industry may be showing signs that it is in its growth phase. Our goal is to select securities that are a leader in a hot industry. (Sector's graphs)

Psychology of Trading: By studying the psychology of the individual, as well as the psychology of the group, we can understand how educated traders can profit by investing against the crowd or by not following the crowd. A visionary trader should also look for a number of psychological reasons that can pushthe price of a stock higher in the future prior to buying it. Support Resistance: The price action of a stock over a period of time will create strength at certain price levels. These levels are recognized as resistance at the top and support at the bottom end of the trading range. This trading range may develop different time frames; it can take from weeks to years or a support and resistance level to develop.

As the price of a stock breaks through the resistance level and moves to a higher level, the level of resistance now becomes the level of support. A new level of resistance will then be formed at some point in the future. On the other hand, as the price range falls below the support level, that level then becomes the new resistance level.

By Ms Suma Madhavi