Apprenticed Investor: Six Keys to Stock Selection

Part of your opinion should include a price target. Let's assume your hypothesis is right -- when the rest of the Street discovers the stock, where can it go? I prefer to use two targets: a reasonable price and a best-case scenario. That way, I can revisit my thesis later and see if a stock that's working is worth sticking with.

The investment thesis should also consider upcoming catalysts, which you should track to both confirm your upbeat view, and to see how the stock reacts.

Stop-Loss

The ideal time to determine a stop-loss is before you buy it -- while you are neutral, and have no emotional investment in the name.

Stop-losses come in many flavors: percentage, trend break, support, moving average. (We will discuss this topic in agonizing detail in the future.)

Your thesis may be your primary motivation for selecting this stock, but it's also a reason to jettison it down the road. When your thesis no longer applies to a given company, it's time to say "buh-bye." Let's say you bought Motorola (MOT Quote) because you so totally respect Ed Zander. If he resigns, guess what? Your purchase thesis has just become inoperative.

Your time horizon is another type of stop-loss. Not only should you determine how much you are willing to give up on any investment, but also how long you are willing to forgo other investments by locking up cash in this name.

Risk-Reward

This is another overlooked aspect of a stock selection. How much potential upside can you legitimately expect vs. your downside risk?

The reason this matters is that all stock-pickers are imperfect. Nobody should expect to be right every time. Indeed, if you are right half the time, consider yourself above average. That's why risk/reward is so important. The investor who bats .500 must not only offset his losses but also his commissions on all trades, and his taxes on the winners.