How to pick potential stocks

Investment tips: How to pick potential stocks
18 Dec, 2011, 0546 hrs IST, Kavita Sriram, ET Bureau
After the correction, the markets have almost reached the bottom. Perhaps, this may be the ideal time to add some new stocks to your basket. Here are some popular stock-picking strategies:

Bottom up investing

Here, the investor filters stocks of companies that have inherently strong fundamentals . Companies are evaluated for strength and efficiency of the management team as well. The ability of the management team in strategic decision-making and building value is a significant contributor to a company's growth.

In a bottom up investing approach, it must be noted that the investor picks a company's stocks based on its performance and fundamentals and not on performance of the sector. Historical performance of the company and its growth prospects also help assess it.

This approach is usually considered a narrow strategy where the broader economic climate and industry performance is not factored in. Investors believe that these companies are fundamentally stronger than the others in the sector, based on their past performance and efficiency of operations. Hence, external factors are believed to have little influence in the stock picking.

Some analysts feel the broader sector trends could impact future performance of the company and not analysing them could blur the decision-making process.

Top down investing

In this method, investors analyse the broader market before narrowing down to individual stocks. GDP, health of the economy and market, interest rates, inflation , geopolitical scenario and global factors are first studied. This is unlike the bottom up method where fundamentals of individual stocks are first analysed before taking into account the expansive global economy.

Next, sectors where investments are prudent to make are identified. Finally, individual stocks from these sectors are identified based on fundamental and technical analysis. An extensive analysis of individual stocks is made by the investor.

A top down approach helps determine the overall market condition and economic climate. It helps build a diversified portfolio with exposure to numerous sectors that are performing well.

In the bottom up approach where investors narrow down on the stocks before considering the economic climate, the possibility of over-exposure to equity is high. A top down approach, on the other hand, could fail if the analysis of the overall economy goes wrong.

Picking bargain stocks at lows could be quite a challenge . Careful analysis and study can help you sail through turbulent times.