Investing in Stocks
How to Select Stocks and Build a Portfolio
In the two previous articles, we explained how to get started buying stocks and introduced several ways to make money in the stock market. This article builds on those foundations by focusing on how to select stocks thoughtfully and assemble a portfolio that balances return potential with risk management.
Selecting Stocks
With thousands of publicly traded companies across global exchanges, successful investing depends less on finding “the next big winner” and more on applying a consistent process. Most individual investors only need between 15 and 20 stocks to achieve effective diversification, making selectivity far more important than volume.
What Does a Share Actually Represent?
When you buy a share, you are purchasing partial ownership in a company. Shares, stocks, and equity all refer to this same concept. In most cases, investors hold ordinary (common) shares, which typically grant:
- Voting rights on key corporate matters
- A proportional claim on company assets after creditors are paid
- Eligibility for dividends, if declared
- The ability to sell or transfer ownership freely
- Access to mandated disclosures and financial statements
- Legal standing to pursue remedies if shareholder rights are violated
While these rights matter, most investors ultimately buy shares to participate in a company’s future earnings and growth. This is where valuation becomes central.
Price vs Value
A stock’s price reflects the current equilibrium between buyers and sellers. Value, by contrast, represents what investors believe the business is worth based on assets, earnings power, growth prospects, and risk.
Markets constantly reassess value. Prices move not simply because new information appears, but because expectations change. Understanding this distinction helps investors avoid reacting emotionally to short-term price movements.
Valuation Frameworks
There is no single “correct” way to value a company. Different frameworks apply in different situations:
- Asset-based valuation: Focuses on net assets or book value, often relevant for asset-heavy or distressed businesses.
- Discounted cash flow (DCF): Estimates the present value of future cash flows, highly sensitive to assumptions.
- Dividend-based models: Useful for mature, income-generating companies.
Each approach involves assumptions that may prove wrong. Valuation is therefore best viewed as a range of probabilities rather than a precise number.
What Causes Valuations to Rise?
For a company’s valuation to increase, the market must believe that future earnings or cash flows will improve. This typically occurs through:
- Revenue growth: From expanding market share or overall market growth
- Improving margins: Through pricing power, efficiency gains, or economies of scale
- Cost control: Reducing overhead while maintaining revenue
Prices often rise in anticipation of improvement rather than after results are reported. Conversely, prices fall when expectations deteriorate—even if current results remain strong.
Key Valuation Ratios
Ratios are most effective when used to compare similar companies or assess changes over time.
Price-to-Earnings (PE) compares share price to earnings per share and reflects growth expectations.
Price-to-Sales (P/S) is useful for companies reinvesting profits or operating at a loss.
EV/EBITDA enables comparisons across firms with different capital structures.
Additional Metrics That Matter
- Market capitalization: Indicates company size and relative stability
- Revenue growth rate: Signals demand momentum
- EPS growth rate: Reflects profitability expansion
- Gross and operating margins: Measure efficiency and pricing power
- Return on equity (ROE): Assesses capital effectiveness
- Debt-to-equity: Highlights financial leverage risk
- Dividend yield and cover: Relevant for income-focused investors
Expectations vs Reality
Markets price in expectations about the future. Stock prices move sharply when reality deviates from those expectations. Good news can lead to falling prices if expectations were too optimistic, while bad news can trigger rallies if outcomes exceed pessimistic forecasts.
Buying Strategies: Value and Momentum
Buy Low, Sell High
Value-oriented strategies focus on buying stocks trading below perceived intrinsic value. This often occurs during market corrections, sector downturns, or temporary company-specific setbacks. The key question is whether the setback is temporary or structural.
Buy High, Sell Higher
Some of the strongest long-term performers never trade at “cheap” valuations. These momentum-driven growth stocks often remain expensive as long as earnings growth and competitive advantages persist. Investing in such stocks requires disciplined risk control.
- Focus on businesses with durable competitive advantages
- Start with smaller positions
- Define acceptable losses before entering a trade
Finding Stocks to Buy
Stock screeners reduce thousands of choices to manageable shortlists. One widely used tool is Finviz, which allows filtering by valuation, growth, sector, and technical criteria. Many brokers also offer integrated screening tools.
When Should You Sell?
Selling discipline often matters more than buying skill. Selling decisions should align with the original investment thesis:
- Sell long-term growth stocks when growth prospects materially change
- Exit momentum positions when trends break decisively
- Cut losses early when a thesis is invalidated
Holding through volatility is often necessary, but holding through broken fundamentals rarely is.
Managing Your Portfolio
Diversification and Asset Allocation
Diversification reduces the impact of individual failures. Research suggests most diversification benefits are achieved with 15–20 stocks. Beyond that, complexity increases without significantly reducing risk.
Reducing Portfolio Volatility
High volatility can provoke emotional decision-making. Including stabilizing assets can help maintain discipline:
- Defensive stocks with stable demand
- Bonds or bond ETFs for income and stability
- Small allocations to gold or cash for downside protection
Choose a Stock Broker
Your broker provides market access, execution quality, and custody. We maintain updated broker guides by region:
Conclusion
Stock investing rewards patience, discipline, and continuous learning. Many investors combine ETFs for broad exposure with a focused selection of individual stocks. Beginners often benefit from starting with ETFs and gradually adding stocks as experience grows.
By understanding valuation, expectations, and portfolio construction, investors can move beyond speculation and build strategies designed to endure across market cycles.
In the two previous articles, we explained how to get started buying stocks and introduced several ways to make money in the stock market. This article builds on those foundations by focusing on how to select stocks thoughtfully and assemble a portfolio that balances return potential with risk management.
Selecting Stocks
With thousands of publicly traded companies across global exchanges, successful investing depends less on finding “the next big winner” and more on applying a consistent process. Most individual investors only need between 15 and 20 stocks to achieve effective diversification, making selectivity far more important than volume.
What Does a Share Actually Represent?
When you buy a share, you are purchasing partial ownership in a company. Shares, stocks, and equity all refer to this same concept. In most cases, investors hold ordinary (common) shares, which typically grant:
- Voting rights on key corporate matters
- A proportional claim on company assets after creditors are paid
- Eligibility for dividends, if declared
- The ability to sell or transfer ownership freely
- Access to mandated disclosures and financial statements
- Legal standing to pursue remedies if shareholder rights are violated
While these rights matter, most investors ultimately buy shares to participate in a company’s future earnings and growth. This is where valuation becomes central.
Price vs Value
A stock’s price reflects the current equilibrium between buyers and sellers. Value, by contrast, represents what investors believe the business is worth based on assets, earnings power, growth prospects, and risk.
Markets constantly reassess value. Prices move not simply because new information appears, but because expectations change. Understanding this distinction helps investors avoid reacting emotionally to short-term price movements.
Valuation Frameworks
There is no single “correct” way to value a company. Different frameworks apply in different situations:
- Asset-based valuation: Focuses on net assets or book value, often relevant for asset-heavy or distressed businesses.
- Discounted cash flow (DCF): Estimates the present value of future cash flows, highly sensitive to assumptions.
- Dividend-based models: Useful for mature, income-generating companies.
Each approach involves assumptions that may prove wrong. Valuation is therefore best viewed as a range of probabilities rather than a precise number.
What Causes Valuations to Rise?
For a company’s valuation to increase, the market must believe that future earnings or cash flows will improve. This typically occurs through:
- Revenue growth: From expanding market share or overall market growth
- Improving margins: Through pricing power, efficiency gains, or economies of scale
- Cost control: Reducing overhead while maintaining revenue
Prices often rise in anticipation of improvement rather than after results are reported. Conversely, prices fall when expectations deteriorate—even if current results remain strong.
Key Valuation Ratios
Ratios are most effective when used to compare similar companies or assess changes over time.
Price-to-Earnings (PE) compares share price to earnings per share and reflects growth expectations.
Price-to-Sales (P/S) is useful for companies reinvesting profits or operating at a loss.
EV/EBITDA enables comparisons across firms with different capital structures.
Additional Metrics That Matter
- Market capitalization: Indicates company size and relative stability
- Revenue growth rate: Signals demand momentum
- EPS growth rate: Reflects profitability expansion
- Gross and operating margins: Measure efficiency and pricing power
- Return on equity (ROE): Assesses capital effectiveness
- Debt-to-equity: Highlights financial leverage risk
- Dividend yield and cover: Relevant for income-focused investors
Expectations vs Reality
Markets price in expectations about the future. Stock prices move sharply when reality deviates from those expectations. Good news can lead to falling prices if expectations were too optimistic, while bad news can trigger rallies if outcomes exceed pessimistic forecasts.
Buying Strategies: Value and Momentum
Buy Low, Sell High
Value-oriented strategies focus on buying stocks trading below perceived intrinsic value. This often occurs during market corrections, sector downturns, or temporary company-specific setbacks. The key question is whether the setback is temporary or structural.
Buy High, Sell Higher
Some of the strongest long-term performers never trade at “cheap” valuations. These momentum-driven growth stocks often remain expensive as long as earnings growth and competitive advantages persist. Investing in such stocks requires disciplined risk control.
- Focus on businesses with durable competitive advantages
- Start with smaller positions
- Define acceptable losses before entering a trade
Finding Stocks to Buy
Stock screeners reduce thousands of choices to manageable shortlists. One widely used tool is Finviz, which allows filtering by valuation, growth, sector, and technical criteria. Many brokers also offer integrated screening tools.
When Should You Sell?
Selling discipline often matters more than buying skill. Selling decisions should align with the original investment thesis:
- Sell long-term growth stocks when growth prospects materially change
- Exit momentum positions when trends break decisively
- Cut losses early when a thesis is invalidated
Holding through volatility is often necessary, but holding through broken fundamentals rarely is.
Managing Your Portfolio
Diversification and Asset Allocation
Diversification reduces the impact of individual failures. Research suggests most diversification benefits are achieved with 15–20 stocks. Beyond that, complexity increases without significantly reducing risk.
Reducing Portfolio Volatility
High volatility can provoke emotional decision-making. Including stabilizing assets can help maintain discipline:
- Defensive stocks with stable demand
- Bonds or bond ETFs for income and stability
- Small allocations to gold or cash for downside protection
Choose a Stock Broker
Your broker provides market access, execution quality, and custody. We maintain updated broker guides by region:
Conclusion
Stock investing rewards patience, discipline, and continuous learning. Many investors combine ETFs for broad exposure with a focused selection of individual stocks. Beginners often benefit from starting with ETFs and gradually adding stocks as experience grows.
By understanding valuation, expectations, and portfolio construction, investors can move beyond speculation and build strategies designed to endure across market cycles.
