How to choose the best companies to invest in and which stocks to buy

"Investing is simple, but it's not easy," Warren Buffet reportedly once said. It seems like a no-brainer to buy undervalued stocks with significant upside potential. However, psychological factors make this difficult, as investors often behave irrationally due to emotions.

Buying the best or most promising stocks is not enough. You should let logic, not emotions , rule your investment portfolio . Therefore, learning behavioral finance separates the most successful investors from the "just good" ones. Some mistakes are inevitable, so the willingness to learn from mistakes is an essential trait for traders and investors.

Equity investments and their valuation

A key aspect to understanding how the world stock market works is to delve into the idea of ​​trading – how is it possible for someone to acquire a share of a company? 

The answer is very simple: investing in stocks is possible for investors worldwide (both institutional and individual) because public companies are listed on a stock exchange (also known as a stock exchange).

The valuation of a stock is a very broad topic, but also a crucial one, as institutional investors often base their decisions on financial modelling. Every investor should be able to understand the basic valuation metrics for stocks like P/E ratio, P/S ratio, EV/EBITDA and others. The multiples approach can be particularly useful because it is relatively easy to use. It is based on the idea that similar stocks trade at similar prices. The method helps investors assess whether the company is undervalued or overvalued relative to companies in the same industry.

Value multiples

To calculate whether the investment in a certain company will generate profit you can use value multiples. With their help, one can determine if there are trading opportunities. The most well-known value multiples are:

1. Earnings per share (EPS) – this is a value multiple that calculates the amount of net income earned per share. In other words, this amount is the money earned per share if the entire profit is divided by the total number of shares at the end of the year. To some extent, it also reflects the profitability of the company from a shareholder's perspective. The higher it is, the more attractive the stock is to investors.

2. Price-earnings ratio (P/E) – The price-earnings ratio is the most well-known indicator for evaluating an investment. The rule of thumb is: the lower the P/E, the more attractive the stock. Despite its imperfections, it is most often reported by market participants. It represents the valuation of a company's share price compared to its earnings per share. A high value ratio means investors have to pay more for today's earnings, while a low value means they are getting cheaper. Additionally, stocks with a high P/E can be overpriced, making them unattractive investments. 

3. Dividend Yield (DY) – indicates how much a company pays out in dividends each year, relative to its share price. Dividend yield is expressed as a percentage and can be calculated by dividing the amount of dividends paid in a given year per share by the value of a share. The report is a useful tool for so-called "dividend investors" who are looking for stocks that have stable growth and pay solid dividends.

There are, of course, many other value multiples that can be used in stock analysis. You have to choose useful indicators in your strategy, just like with dividend yield.

Stock CFDs

CFDs are much more flexible than classic shares, giving you the opportunity to profit from any price movement, up or down, when the market moves according to your predictions. Trading CFDs allows you to open long (buy) trades if you think the price of a share will rise or short (sell) trades if you think the price will fall.

In contrast, buying a CFD does not give you ownership in a company. On the other hand, buying a classic stock, yes. This means that you can decide on the future of the company if you own its shares and if you own a significant number of shares, of course, which is not possible when you own a CFD.

Even in the case of stock CFDs, you can look for companies that pay dividends because through CFDs you can benefit from cash adjustments, the equivalent of the net dividend (long positions are subject to a positive cash adjustment) or gross (short positions are subject a negative cash adjustment).

Identifying trading opportunities

Market Screener is a very useful tool that helps us identify potential trading opportunities in a much faster and more efficient way. For example, you may be interested in companies with a P/E ratio greater than 1.5, or simply looking to invest in large-cap stocks. This is where the Market Screener comes in.

The beauty of this tool is the ability to search hundreds of markets globally in an instant and filter the results by very specific criteria. It helps create trading strategies ultimately saving time and effort.

A portfolio of investments as diverse as possible

Diversification is nothing more than making sure you don't "put all your eggs in one basket" because if that basket falls, all your eggs will break. One method of diversification is by market capitalization. Market capitalization refers to the total value of all publicly traded shares of a given company. This is the method of determining the size of the company.

The ability to vary investments through instruments from different countries / regions of the world is another form of diversification. For example, instead of holding only American companies, you can compose your portfolio with shares of companies based in the United States, the United Kingdom, and Germany. Thus, it is possible to create a portfolio based, for example, 50% on developed markets and 50% on emerging markets.

You can also apply diversification by stock market indices . Apart from US or European indices, XTB offers access to CFDs on Asian or South American stock indices.

You can add gold ETFs or CFDs to your investment portfolio. These instruments usually increase when a crisis affects the economy. Therefore, in addition to the described methods of diversification, diversification between markets is also worth considering. You can also easily change the size of your exposure to individual markets.

An efficient and "user friendly" trading platform 

Building a diversified portfolio and maintaining permanent contact with investments is based on a state-of-the-art trading platform, such as xStation 5 , also available in a mobile version , which you can access whenever you want and wherever you are. Having multiple categories of instruments available just a few clicks away is very important for a successful trading strategy. A platform must be user-friendly and intuitive, easy to use and, above all, always accessible.

Whether we're talking about stocks, ETFs, equity instruments or derivatives, CFDs, Forex instruments, it's important to be able to access them all in the same platform and to have as wide a range of markets, industries, areas as possible geographically, in such a way as to allow healthy diversification of the portfolio and adequate risk management .

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