The outcome of an investment largely depends on the selection of stocks, pretty much make or break thing. That is why during this whole process, a large chunk of time and effort should be allocated in finding the right scrips ensuring the desired result to a great extent.

Probably, the biggest mistake an investor in his initial years would make is to jump on the trading aspect without assessing the market and eventually it leads to hefty loss and thereby they are inclined to quit the game. So, here’s a guideline that you could follow for choosing the right stocks and maybe amend it to your understanding. It certainly does not mean that every trade of yours will turn out to be profitable, however, for me it always results in a greater ratio of profitable trades than the loss-making ones.

– LOOK OUT FOR ECONOMIC TRENDS

All your decisions will greatly depend on your understanding of economic trends and to what an extent, you form a close to accurate expectation. In my opinion, the following statistics will enable you to grasp the market conditions:

o Interest Rate

o Inflation

o Foreign Reserves

o Exchange Rate & Fuel Prices

o Government Support

A brief document issued by the State Bank of Pakistan every two months in lieu of Monetary Policy Statement (MPS) is quite wholesome in this regard. It not only reports relevant facts and figures but also attempts to explore how the trends might change in coming times. In case you are interested to evaluate the market in great detail and deeply understand the ground realities, you can consult Pakistan Bureau of Statistics or the reports issued by IMF, WB & ADB.

– SELECT SECTORS BASED ON YOUR EARLIER ANALYIS

I will restrict it to six sectors that I have traded in, over time, and alongside mention the factors that would be vital towards forming an opinion towards a particular sector. I prefer that at least 50% of these factors should make a particular sector more favorable (If a sector has 3 things to look upon at least 2/3 should have a positive outlook). Still if things are not unclear, it is desirable that one should have a clear point on how the overall market will perform in future and then check on the sector’s correlation with it. Thus if it is expected that market will have a bullish trend and the sector’s performance closely correlates with it, so despite you were earlier confused, it could help you have a clear stance.

o BANKING SECTOR

§ Interest Rate has mostly a positive relation with the performance of banking sector.

§ GDP growth too has a positive relation with the performance of banking sector

§ Regulations in banking have an adverse impact on the performance of Banking sector

o AUTOMOBILE SECTOR

§ Depreciating foreign exchange would have an adverse impact on performance of Automobile sector.

§ Taxes (Non-Filer) on ownership and transfer, drive investors away and thus again negatively impact the performance of Automobile sector.

§ Import duty has an inverse relation with performance of Automobile sector.

o CEMENT SECTOR

§ Fuel/Gas prices have an inverse relation with performance of cement sector.

§ Proportion of development budget and extent of government support has a positive relation with performance of cement sector.

§ Interest rate has an inverse relation with performance of cement sector.

o FERTILIZER SECTOR

§ Performance of Agriculture sector last would greatly decide the short-term fate of fertilizer sector.

§ Fuel/Gas prices have an inverse relation with performance of fertilizer sector.

§ Subsidies and related trends would have a positive impact on fertilizer since the demand is essentially a derived demand.

o OIL/GAS MARKETING AND EXPLORATION

§ Petroleum taxes have a considerable negative impact on marketing companies with a minute effect on exploration segment

§ Automobile sales in the country for a given time period would evenly effect both sector.

§ Certainly, international oil prices would greatly dictate the market conditions.

o ENERGY SECTOR

§ Since cost of energy hugely depends on fuel and gas prices, a rise would have an adverse impact on IPPs.

§ Circular Debt position at a given point would be crucial to the whole sector.

§ Expectation of upcoming energy sukuk or related financing facility would lead to a positive for the energy sector.

– CHOOSING SCRIPS AND FINAL CALL

This is the final step of this three-step approach. While the dynamics may vary from sector to sector, some aspects certainly remain unchanged and are of great importance in making the right choice. Again, 50% or more of the factors should tilt in favor of a particular stock and there is still confusion,look for a stable betaand price history & extend the trendline.

o FINANCIALS

§ Compare EPS over at least 3 years, ideally five years. Analyze the change overtime and form an expectation [MA(5)/MA(3)]

§ Avoid shares with consistently high dividend payout ratio (>80%). Firms with over 100% payout ratio for two years out of the five years under consideration should be strictly avoided.

§ Preferably, P/E ratio for the scrip should be higher than the sector P/E.

o QUALITATIVE

§ Chairman’s review is one of the key things investors study and often forms a base for speculation. (Think how will you expect price to change given these expectations turn out to be true)

§ Look out for any firm-specific SECP announcements, it could be pretty useful in swing trade.

o LIQUIDITY/VOLUME

§ At least the traded volume per day should be 200,000, with minimal volatility. For blue-chip stocks, scrips with 1 million share volume are considered liquid.

§ Shares with consistent presence in active stocks should be preferred.

§ Scrips with high investment proportion from mutual funds are recommended.

Finally, once you have made a firm decision to buy a certain stock execute the trade within (+5%) prevailing market price.

Set strict deadlines; ONE MONTH, SIX MONTHS, ONE YEAR. (You can even be more precise).

If your target price is met well before, sell it and don’t hold, only to regret the lost profit.

Finally, have a penny stock in your portfolio it could really come handy at times.

Happy Trading 🙂