Is Stock Picking Profitable?

Shutterstock

There are two ways to play the market. You can choose a portfolio manager or pick your own stocks. One is passive, and the other one is active investing. Many investors want to follow in the footsteps of stock-picker success story Warren Buffet and become active investors.

Active investing plays into overconfidence bias. This is when people overestimate the probability of a good outcome. They also underestimate the probability of a bad outcome. Stock pickers assume they’re going to win. But is stock picking the best way to beat the stock market?

Is Stock Picking a Good Strategy?

Stock picking usually underperforms a passive strategy. That’s because a passive or portfolio managed strategy tracks the broader stock market indexes.

Most stock pickers downplay the possibility of a bad outcome. They listen to others who push a compelling story to pick stocks with their help—but it’s still only a story.

Active investing is difficult because, over a long time, the markets tend to be efficient. That is because there’s the efficient market hypothesis (EMH) that market prices reflect all available information. In other words, the EMH implies that there is no hope of beating the market, although returns can be matched through passive index investing.

But to be fair, some question this hypothesis. They point to investors like Mr. Buffet, who focused on undervalued stocks and made billions.

Proponents of EMH claim that those who outperform the market don’t use skill. Instead, they’re lucky. This is because the laws of probability say that there will be some winners and losers at any given time.

Stock Market Historically Dangerous

The odds are stacked against you when it comes to capturing rising stars. This is a capitalistic society, so for every Walmart, there are numerous regional retailers that couldn’t cut it. And among some of the past stars, several stocks experienced declines.

Stocks that had 70 percent declines run the gambit of the stock market. Some of these were once the stock market darlings. For example, according to JP Morgan, those percentages of categories that experienced “catastrophic losses” between 1980 and 2014 include:

• 57 percent of technology
• 51 percent of telecommunication services
• 47 percent of energy percent
• 43 percent consumer discretionary

From 1980 to the early 2000s, 40 percent of all stocks suffered a permanent 70 percent decline from their peak. These were not temporary losses. Many stocks from the tech boom-bust or the financial crisis did decline but rebounded. Technology companies have been a rollercoaster.

For example, the tech-heavy Nasdaq had a 33 percent plunge in 2022, but experienced a 43 percent rebound in 2023. It’s a marathon.

It comes down to trying to select individual stocks that outperform the market. This is easier said than done. It is probably not possible for a stock picker to beat a buy-and-hold investor with the same stocks.

Stock-Picking Services

Stock-picking services may help active investors. They narrow down the thousands of possible stocks and help investors choose the best stocks for their portfolios.

Most of these stock-picking services are paid. Free stock-picking services are available, but are not as comprehensive in their offerings. Some popular paid stock picking services include:

• Motley Fool—$199 monthly
• Trade Ideas—$84 to $167 monthly
• Morningstar Investor—$34.95 monthly
• Zacks Investor Collection—$59 monthly

There are many more available, but do your research and read reviews to find one that suits your investment style and budget. You’ll also want to analyze the stock-picking service’s track record. A service should tell you both their winners and losers. Beware of a company padding their wins.

Anything worthwhile comes at a cost. And stock-picking services are no exception. Be aware of what a service is costing you. Decide on whether the price is worth it to you.

Look for a user-friendly platform. How do they share their stock picks? Check if they send in-depth reports, entries, exits, etc.

You'll also want to find a stock-picking service that aligns with your philosophy. For example, if you’re interested in new opportunities, like tech startups, find a stock-pricing service specializing in them.

Many more are available, but research and read reviews to find one that suits your investment style and budget.

Stock Pickers Must Research and Understand Market

If you want to be a stock picker, establish an investing goal. A young investor will have different goals than one approaching retirement.

Look for companies you understand. You probably wouldn’t buy a roofing company if you didn’t understand roofing. The same goes for stocks. If you don’t understand what the tech company is doing, evaluating its market is hard. So, if you don’t know exactly what a company does, pass.

Does the company you’re interested in have a competitive edge? Buffet calls a company with a sustainable advantage a moat. He said, “The products or services that have wide, sustainable moats around them are the ones that deliver reward to investors.”

Learn to determine a fair price. Understand price-to-earnings ratios, price-to sales ratios, discounted cashflow modeling, and dividend yield.

Once you have a fair price, buy a stock with a margin of safety. This means if the valuation is wrong, you’re preventing big losses because you bought below the fair price.

Going It Alone Is Risky

There are some stock pickers who are winners. Mr. Buffet has proved that. But it’s probably wise to treat the exception like an exception when it comes to stock picking.

According to a Hendrik Bessembinder analysis, after a survey of 15,000 firms, six out of 10 stocks lost investors’ money. Those may not be the best odds to beat the stock market.

The Epoch Times copyright © 2024. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.