Step 1: Plan it Out.
When choosing a source image, you want to make sure it will work as a stencil. For example, a very overexposed or washed out image won't work very well, because you're missing the details that make it recognizable. With certain subject matter there are certain details that make of break the piece (for example, with people, the eyes are what gives life to the image, with buildings it's the rooflines that define the form, and so forth). Think it out in advance as much as you can, and don't be scared to work with bits and pieces of multiple images to get exactly what you want. For example, let's say you want a stencil of George Bush bending over, and you don't want to draw it freehand. Well, you're never going to find a picture of that to work from, but you sure can take a picture of a friend in a suit and stick George's head onto it in Photoshop. Or see what you can do freehand. Remember, stencils are a form of illustration. Don't marry yourself to the photo.