Equity investments historically have enjoyed a return significantly above other type’s investments while also proving easy liquidity, total visibility, and active regulation to ensure a level playing field for all but many people is looking for a quick and easy way to riches and happiness from stock markets in short term but hardly some make returns. We have seen that most of the investors investing directly in the equity market take decisions based on poor research, gut feel or stock tips, which is a highly unstructured manner. Thus, it does not help in generating long-term wealth. The net result is erratic and sub-optimal equity returns.
Every investor has a dream that He/She should create a portfolio of stocks, which should generate wealth for him/her. To create such a portfolio successfully in the stock market, it’s really important that you learn how to become a good stock picker. It is the single most important quality required in a person who wants to be a successful stock market investor.
For beginner, here are a few things to consider before you pick stocks:
SHORT LIST GOOD FUNDAMENTALS COMPANY:
To find a fundamentally strong company. You can filter the healthy companies so that you can proceed to investigate further. If the company is not fundamentally strong, there is no need to learn more about its products/services, competitors, future prospects etc. Here are eight financial ratios and their trend that should be carefully noted in this step:
- Earnings Per Share (EPS) – Increasing for last 5 year.
- Price to Earnings Ratio (P/E) – Low compared to companies in the same industry.
- Price to Book Ratio (P/B) – Low compared companies in the same industry
- Debt to Equity Ratio – Should be less than 1
- Return on Equity (ROE) – Should be greater than 15
- Dividend – Increasing for the last 5 years
Once you are confident that the company fulfill most of the criteria mentioned above, then study the financial reports of the company. The process of shortlisting companies is necessary so that an investor can focus his/her limited time and effort on a few targeted companies. Shortlisting companies before analysis helps an investor get maximum benefit out of his/her effort. This data is available in the public financial sources like Moneycontrol etc.
UNDERSTAND THE PRODUCTS OR SERVICES OFFERED BY THE COMPANY:
After filtering the companies based on their financial fundamentals, you need to investigate the company. Understand the company first. Learn about its products and services. It’s important that the company is easy-to-understand and has a fairly straightforward business model. There are a number of companies that everyone knows and understands. From toothpaste, soaps, towels, t-shirts, jeans, shoes to bikes, cars, airlines, banks; there is a company behind every product. Invest in such companies.
Learn what this company is doing which its competitors are not. Competitive advantage basically is something that adds value and, is unique to the firm. In simple terms, competitive advantage differentiates great companies from good companies. For example, Asian Paints outperformed all its competitors due to some unique capabilities that it developed over the years. The company has a wide distribution network, provides great quality products and has a very strong brand name. Thus, we can say that a firm with a competitive advantage(s) over its peers will create higher value and will be able to garner more respect from the market.
INVEST IN COMPANIES WITH ‘MOAT’
This ‘MOAT’ concept was popularized by Mr. Warren Buffet. These are basically such companies which primarily operates as a monopoly business. These companies gets highlighted by their high profit-margin levels. Maggie, Nescafe (Nestle India), Chawanprash (Dabur), IRCTC(Railways), Pizza (Dominoes–Jubilant Foodworks) are examples of MOAT companies.
AVOID COMPANIES WITH BIG DEBT:
Generally, too much debt is a bad thing for companies and shareholders because it inhibits a company’s ability to create a cash surplus. Big debts in a company are the same as the big hole in the Ship. If the hole in the Ship is not filled soon, then it won’t be able to cross the long sea and will definitely sink. While investing in the company Debt to Equity Ratio should be checked .Avoid companies with huge Debt.
The management is the soul of the company. A good management can prosper the company to new heights. On the other hand, a bad management can lead to the downfall of the company. Hence, it’s really important to research carefully about the management of the company that you plan to invest. Here are a few points to check the efficiency of the Management.
Vision and Goals: Go through the Vision, Mission and Value statement of the company. Together, mission and vision guide strategy development, help communicate the company’s purpose to shareholders and inform the goals and objectives set to determine whether the strategy is on track.
Promoter’s buying Stocks: Generally, the promoter’s buying and share buybacks are signals of good company. However, we cannot judge the company’s future based on the promoter’s selling the stock. Please note, if the promoters are selling a lot of stocks continuously without explaining the reason, then it’s a matter to investigate further.
Promoter’s Salary: The salary taken by the promoter/management of the company is one of the key parameters that can give critical insights into the management intentions.
Related Party Transactions: By studying this, an investor can conclude whether the promoters are benefiting from the company at the cost of minority shareholders. Related party transactions are provided by the company in annual Report.
These are the key points to consider while choosing a stock to invest in. Keep learning and Happy Investing.
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