How to pick stocks: the seven-step walkthrough

Nearly 90 percent of active US funds trail their benchmark over 15 years (SPIVA); here is the seven-step process for picking your own.

The comfortable belief is that picking stocks is a coin flip, that the sensible move is to hand your money to a professional and never look at a balance sheet again. The numbers seem to back it: nearly 90 percent of actively managed US large-cap funds trailed the S&P 500 over the fifteen years to the end of 2024 (SPIVA). But read that figure again, because it cuts the other way. The people losing to the index are the professionals — the research teams, the trading floors, the analysts with Bloomberg terminals. Their record isn’t an argument against picking stocks. It’s an argument against picking them the way the crowd does: chasing stories, hugging benchmarks, buying what everyone already owns. What beats that isn’t genius. It’s a process — the same disciplined loop, run every time. Here is the one we’d run.

Step 1 — Know your hunting ground

Before you screen a single company, decide where you are allowed to hunt. Your circle of competence (the set of businesses you actually understand) is smaller than your ego wants it to be, and that’s fine — the size of the circle never mattered, only knowing its edge. If you can’t explain in a sentence how a company turns effort into cash, it sits outside the line, no matter how exciting the chart looks. Staying inside isn’t timidity; it’s the one structural advantage you hold over a fund manager forced to own every heavyweight in the index. You can simply decline to play in games you don’t understand. That’s the whole point of buying what you understand: it turns ignorance from a risk into a boundary.

Step 2 — Screen, don’t browse

The investable universe holds over 8,000 companies. You will never read your way through it, and browsing — clicking around, reacting to whatever scrolls past — is how good intentions become a portfolio of headlines. The fix is a screen (a filter that cuts the universe to the names worth your attention) run the same way every month. Constrain to your hunting ground, sort by the ranks that match your strategy, save the filter so next month starts where this one ended. That is the entire difference between investing and shopping. The mechanics of getting from 8,000 stocks to a shortlist live on Discover, and they take minutes. The discipline of running them takes a decision.

Step 3 — Understand how the business wins

A shortlist is a list of candidates, not a list of buys. For each survivor, ask the question a screen can’t: why does this company keep its profits when competitors would love to take them? That durable edge is an economic moat (a structural advantage that protects returns over time) — a brand customers won’t abandon, a network that grows more useful with every user, switching costs that make leaving painful. A business without one is a business whose good years invite the competition that ends them. The moat is what lets a winner stay a winner long enough for your patience to pay. Spend your research time here, on what an economic moat actually is, because everything downstream assumes the business survives. A cheap stock with no moat is just a slower way to lose.

Step 4 — Check what the crowd thinks

Now look at the consensus — not to obey it, but to locate yourself relative to it. The sentiment ranks on each stock page condense what the market already believes: analyst opinions, professional holdings, recent changes of mind, the news-driven pulse. The use isn’t to buy what’s popular. Popular is usually priced in. The use is to know whether your thesis (your written reason for buying) agrees with the crowd or fights it, because the two situations demand very different conviction. Agreeing with a euphoric market means you’re paying for optimism everyone shares. Fighting a gloomy one means you need to be right about something most people are getting wrong — and you need to know that’s the bet you’re making. Sentiment doesn’t tell you what to do. It tells you what game you’re in.

Step 5 — Verify the numbers

A moat and a story can both be real while the accounting quietly isn’t. Before you commit, verify the numbers underneath the ranks: are earnings backed by cash actually coming in the door, or by accruals (book entries that record revenue before the money arrives)? Is debt growing faster than the business that has to service it? Are the margins that justify the price stable, or propped up by a one-off the company would rather you read as permanent? Earnings quality (how closely reported profit tracks real cash) is the difference between a number you can trust and a number you’ll regret. You don’t need to be a forensic accountant. You need to look for the red flags that the people who lost to the index didn’t bother to check. Most blowups were legible in advance. Someone just had to read.

Step 6 — Demand a discount

You can be right about the business and still lose money, because the price you pay is a separate decision from the company you buy. The guard against that is a margin of safety (the gap between what a business is worth and what you pay for it). Estimate the value conservatively, then insist on buying meaningfully below it — not because your estimate is precise, but precisely because it isn’t. The discount is what absorbs the things you got wrong, the surprises no screen could see, the patience the market will test. Overpay for a wonderful company and you’ve turned a good business into a bad investment. The point of buying below worth is that it lets you be wrong and still come out whole. Price is what protects you from yourself.

Step 7 — Size it, write it down, watch it

A buy decision isn’t finished when you click. Decide how much to own — position size (the share of your portfolio a single stock gets) is the lever that decides whether one mistake is a lesson or a catastrophe, and the answer to how many stocks you should own is rarely as many as you think. Then write the thesis down in one line, so future-you can audit past-you honestly instead of inventing a story that fits the price. Finally, put it on a watchlistand let the ranks tell you when the facts change. The written thesis is what turns a hunch into something you can be held to. That’s the whole job.

Where to go next

Each step above has a fuller treatment. Read them in order the first time, then keep them as a checklist you can return to whenever a stock tempts you to skip a step:

There have always been two ways to invest: hand it to a professional who, the SPIVA record suggests, will probably trail the index, or trade on instinct and hope your instincts are better than theirs. Obermatt is the third way — the same seven-step loop, run on peer-relative ranks, the same way every month, so the discipline lives in the process instead of in your willpower. The ranks won’t pick for you; nothing should. They just make the boring, repeatable work fast enough to actually do. And in the end that is all stock-picking has ever asked of you: not to be smarter than the market, only more patient than the people who quit the process.