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How to Pick Stocks: A 7-Step Checklist for Beginners (With a Free Scorecard)

Before you start: the honest truth about picking stocks

Most professional fund managers, people paid millions to pick stocks, fail to beat a simple index fund over 10 to 15 years. That's the consistent finding of S&P's SPIVA reports.

That doesn't mean you shouldn't pick stocks. It means you should do it with a method and a small slice of your money, while an index fund does the heavy lifting. We compare the two approaches in index funds vs picking stocks.

Here's the method.

The 7-step stock-picking checklist

Step 1: Do you understand how the company makes money?

Write one sentence: "This company makes money by ______." If you can't, stop here.

Then answer three questions:

• Who are its customers? Consumers, businesses or governments?
• What does it sell? Products, subscriptions, ads, services?
• Who are its competitors?

Warren Buffett calls this staying inside your circle of competence. You'll judge a business far better if you understand it.

Where to look: the "Business" section at the start of the company's annual report (called a 10-K in the US), on the SEC's free EDGAR site or the company's investor relations page.

Step 2: Is revenue growing?

Revenue (or sales) is all the money a company brings in. Growing companies tend to make growing profits.

Look at at least five years, not just the latest quarter. Steady growth beats one big jump.

Step 3: Is it profitable, with healthy margins?

Revenue isn't profit. Check:

• Net income: is the company making money at all?
• Net profit margin = net income ÷ revenue. It shows how many cents of profit the company keeps from each dollar of sales.
• Return on equity (ROE): profit compared with shareholders' money. Above 15% consistently is strong.

Margins vary by industry. A supermarket might keep 2 to 3 cents per dollar; a software company might keep 25 or more. Compare a company with its own industry, and check whether margins are rising or falling.

Step 4: Can it handle its debt?

Debt isn't bad by itself, but too much sinks companies in recessions or when interest rates rise, which they did in 2026.

Banks, utilities and real estate companies naturally carry more debt, so compare them with peers. And watch for debts that hide off the balance sheet, such as long leases. See how to read off-balance-sheet obligations.

Step 5: Does it generate free cash flow?

Profits can be shaped by accounting choices. Cash is harder to fake.

Free cash flow = cash from operations − capital spending.

It's the money left over after the company pays to run and maintain the business. That's what funds dividends, buybacks, debt repayment and growth. Look for free cash flow that's positive and growing, and roughly in line with net income over time.

Step 6: Does it have a moat?

A moat is a lasting advantage that keeps competitors away, like the moat around a castle. Without one, high profits attract rivals and get competed away.

The five common moats:

1. Brand: people pay more for the name (Apple, Coca-Cola).
2. Network effects: the product gets better as more people use it (Visa, marketplaces).
3. Switching costs: it's painful to leave (business software, banks).
4. Cost advantage: it makes things cheaper than anyone else (Costco, large miners).
5. Patents and licences: the law keeps rivals out (drug makers, railways).

A good test: if a rich competitor spent billions attacking this company, would it succeed?

Step 7: Is the price reasonable?

A great company can be a bad investment if you pay too much. Three simple valuation tools:

• P/E ratio = share price ÷ earnings per share. It tells you how many dollars you pay for each dollar of yearly profit. The S&P 500's long-run average is in the mid-to-high teens. Full guide: the P/E ratio explained.
• PEG ratio = P/E ÷ expected earnings growth rate. It adjusts the P/E for growth. Around 1 or below suggests the price is reasonable for the growth you're getting.
• Price-to-free-cash-flow = market value ÷ free cash flow. Useful when earnings are distorted by one-time charges.

Always compare with the company's own history and its competitors. A P/E of 30 can be cheap for a company growing 30% a year, and a P/E of 10 can be expensive for one that's shrinking.

Your free stock scorecard

Score each line 0, 1 or 2. A total of 11 or more out of 14 is worth deeper research. Below 8, move on.

Copy it into a notebook or spreadsheet and fill it in for every stock you consider. Writing it down stops you from buying on excitement.

How to find stocks to check

You need a shortlist before you can use the checklist. Good places to start:

• Companies you already know as a customer or employee.
• The largest holdings of an index fund you own.
• A free stock screener. Set filters like "revenue growth above 10%, debt-to-equity below 1, P/E below 25." Our ranking of the best free stock screeners shows which ones are easiest to use.

Step 8 (the one people skip): how much to buy

Even a good stock can fall 50%. Size your bets so that being wrong doesn't hurt much:

• Keep any single stock below 5% of your portfolio as a beginner.
• Hold at least 15 to 20 stocks across different industries if individual stocks are your main investment.
• Or keep 80% to 90% in an index fund and use the rest for stocks you pick. Many investors find this the best of both worlds.

You can buy small amounts even of expensive stocks with fractional shares. Compare the best brokers for fractional shares.

Seven beginner mistakes that cost the most money

1. Buying tips from social media without doing the checklist.
2. Confusing a great company with a great stock. Price matters.
3. Buying because the price fell. Cheap stocks can get cheaper. Check why it fell.
4. Putting too much into one stock. See why concentration is risky.
5. Selling winners too early and holding losers too long.
6. Checking prices every day. It leads to emotional decisions. See why you should stop checking.
7. Ignoring fees and taxes. Frequent trading in a taxable account adds up.

Where to practise first

Before you use real money, try paper trading, buying and selling with pretend money. Most brokers offer it, and so does our free paper trading tool. Then, when you're ready, open an account with one of the best brokers for beginners (or in Canada).

The bottom line

Picking stocks isn't magic. It's seven questions: Do I understand it? Is it growing? Is it profitable? Is the debt safe? Does it make cash? Does it have a moat? Is the price fair? Answer them honestly, write down your score, buy a sensible amount and hold for years, not days.

Frequently asked questions